The Coca-Cola Company (NYSE:KO) is Getting Expensive for Yield Investors

Key Takeaways:

• Guidance raise means more than earnings beat
• Investors should look beyond the Non-GAAP earnings
• The dividend yield is below the long-term average

When the company misses the earnings guidance once in a blue moon, its positive results hardly surprise anyone. Yet, The Coca-Cola Company (NYSE: KO) results were more exuberated after the beverage company raised the revenue expectations for the full year.

Check out our latest analysis for Coca-Cola

Second quarter Coca-Cola 2022 results

• EPS: US$0.44 (down from US$0.61 in 2Q 2021).
• Revenue: US$11.3b (up 12% from 2Q 2021).
• Net income: US$1.91b (down 28% from 2Q 2021).
• Profit margin: 17% (down from 26% in 2Q 2021). Higher expenses drove the decrease in the margin.

Over the next year, revenue is forecast to grow 4.0%, compared to a 5.5% growth forecast for the industry in the US. Over the last 3 years on average, earnings per share have increased by 6% per year, and the company’s share price has also increased by 6% per year.

While the market is talking about solid earnings beat, we must notice that many reported numbers are not by the generally accepted accounting principles (GAAP). Non-GAAP reporting gives a larger leeway for misinterpretation of real financial data.

If we look deeper, we can see that among inflationary and supply chain concerns operating GAAP operating margin dropped 910 bps.

What Does the Price Tell Us?

With a price-to-earnings (or "P/E") ratio of 28.5x, The Coca-Cola Company (NYSE: KO) is on the pricier side of the market, given that almost half of all companies in the United States have P/E ratios under 15x and even P/E's lower than 8x are not unusual.

Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Coca-Cola.

Does Growth Match The High P/E?

To justify its P/E ratio, Coca-Cola would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 18% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 34% in total over the last three years. Overall, growth was there.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 8.6% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 10% per year, which is not materially different.  It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Bottom Line On Coca-Cola's P/E

Coca-Cola is currently trading at a premium as it seems the investors are looking beyond the unimpressive growth in the near future.  Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal what other market participants think about the company.

However, there is one important thing to point out. Coca-Cola has been revered for its rock-solid dividend. Looking beyond just the P/E ratio, we see that the dividend yields around 2.79% - below its long-term average of 3.7%. With shrinking margin and free cash flow, we wouldn't be expecting an extraordinary dividend hike as the company already pays the majority of its free cash flow as dividends.

It's always necessary to consider the ever-present investment risk. We've identified 1 warning sign with Coca-Cola, and understanding should be part of your investment process.

If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/Es below 20x.

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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.