Stock Analysis

Slowbalization Should Not Damage The Coca-Cola Company's (NYSE:KO) High ROE

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NYSE:KO
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Although The Coca-Cola Company ( NYSE: KO ) has been ranging in the recent weeks, fans of technical analysis might be excited as the price is forming a flag, signaling for more upside.

While the market is looking up to the pre-pandemic key level of US$60, which has still not been recaptured, there are few if any positive catalysts on the horizon. If anything, the company is facing headwinds with supply chain issues.

This article will examine those issues, as well as the current state of return on equity (ROE).

Check out our latest analysis for Coca-Cola

Slowbalization has arrived

According to data by PIEE , global trade has pulled back for the first time since the world wars. Globalization started a positive trend after WW2, but it really took off after China opened up in the 1980s. After the fall of the Soviet Union ended the Cold War, it also allowed access to eastern European and central Asian markets. The final positive catalyst in the story was the rise of information technology that had many benefits.

Trade openness Index, Source: PIEE

However, after facing a number of serious accusations through the years, including pollution, racial discrimination, and anti-competitiveness, the ongoing global supply chain crisis is starting to impact the company. The shortage of aluminum cans , as well as a shortage of heavy goods vehicle drivers (HGV) is now evident across the UK, as well as some parts of the EU.

Meanwhile, Coca-Cola Australia has launched a Topo Chico Hard Seltzer, the company's first alcoholic drink in the country. The category of alcoholic sparkling water is becoming a hit on the Australian market , with projected sales as high as AU$300m by 2025.

Examining the Return On Equity

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money.In short, ROE shows the profit each dollar generates concerning its shareholder investments.

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Coca-Cola is:

33% = US$8.1b ÷ US$24b (Based on the trailing twelve months to July 2021).

The 'return' is the amount earned after tax over the last twelve months.That means that for every $1 worth of shareholders' equity, the company generated $0.33 in profit.

Does Coca-Cola Have A Good ROE?

One simple way to determine if a company has a good return on equity is to compare it to the average for its industry.However, this method is only useful as a rough check because companies differ quite within the same industry classification.

Pleasingly, Coca-Cola has a superior ROE than the average (14%) in the Beverage industry.

roe
NYSE: KO Return on Equity September 3rd, 2021

That is a good sign.Bear in mind; a high ROE doesn't always mean superior financial performance.Especially when a firm uses high levels of debt to finance its debt which may boost its ROE, the high leverage puts the company at risk. You can see the 2 risks we identified for Coca-Cola by visiting our risks dashboard for free on our platform.

The Importance Of Debt To Return On Equity

Companies usually need to invest money to grow their profits.That cash can come from issuing shares, retained earnings, or debt.In the first and second options, the ROE will reflect this use of cash for growth.In the latter case, the debt required for growth will boost returns but not impact the shareholders' equity.In this manner, the use of debt will boost ROE, even though the core economics of the business stay the same.

Coca-Cola's Debt And Its 33% ROE

It's worth noting the high use of debt by Coca-Cola, leading to its debt to equity ratio of 1.73.While its ROE is undoubtedly impressive, we would have been even more impressed had the company achieved this with lower debt.Debt does bring extra risk, so it's only really worthwhile when a company generates decent returns.

Conclusion

Return on equity is a useful indicator of the ability of a business to generate profits and return them to shareholders.In our books, the highest quality companies have high returns on equity, despite the low debt. All else being equal, a higher ROE is better. And while the company is undoubtedly facing short-term pressures in the supply chain, according to our forecasts , its ROE will increase in the 3-year period.

Having said that, while ROE is a useful indicator of business quality, you'll have to look at a whole range of factors to determine the right price to buy a stock.Profit growth rates versus the expectations reflected in the price of the stock are vital to consider. So you might want to check this FREE visualization of analyst forecasts for the company .

Of course, Coca-Cola may not be the best stock to buy . So you may wish to see this free collection of other companies with high ROE and low debt.

What are the risks and opportunities for Coca-Cola?

The Coca-Cola Company, a beverage company, manufactures, markets, and sells various nonalcoholic beverages worldwide.

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Rewards

  • Trading at 21.3% below our estimate of its fair value

  • Earnings are forecast to grow 7.13% per year

  • Earnings grew by 12.7% over the past year

Risks

  • Significant insider selling over the past 3 months

  • Has a high level of debt

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Share Price

Market Cap

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Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

Stjepan Kalinic

Stjepan Kalinic

Stjepan is a writer and an analyst covering equity markets. As a former multi-asset analyst, he prefers to look beyond the surface and uncover ideas that might not be on retail investors' radar. You can find his research all over the internet, including Simply Wall St News, Yahoo Finance, Benzinga, Vincent, and Barron's.

About NYSE:KO

Coca-Cola

The Coca-Cola Company, a beverage company, manufactures, markets, and sells various nonalcoholic beverages worldwide.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation4
Future Growth2
Past Performance4
Financial Health4
Dividends5

Read more about these checks in the individual report sections or in our analysis model.

Established dividend payer and good value.