“The definition of insanity is doing the same thing over and over and expecting different results”. Benjamin Franklin
“Deutsche Bank has hiked its price target on Coca-Cola Co. (KO) shares to $57 from $50, representing upside of roughly 19% from the stock’s current trading level. The firm noted that Coca-Cola’s operating profit has risen 24% since July 23, 2004 to an estimated $7.1-billion this year. While its dividends are also 33% higher, the shares are trading $1.50, or 2.5% lower, versus a 32% gain for the S&P 500 during the same period. “Against this, we see Coke today as better positioned to address the core strategic challenge – managing a wider portfolio while lowering distribution and input costs,” the firm said, changing its recommendation to “buy” from “hold.”
Not to be outdone, Morgan Stanley on 2/23 raised its rating on Coca-Cola to “overweight” from “equal-weight,” citing attractive valuation and improving operations fueled by strong performance in emerging markets.The investment bank, in a research note, said valuation was attractive with potential gains of 18 percent to its $56 price target on the stock
Because two is not a number that officially qualifies a group as “lemmings”, Goldman Sach’s Judy Hong joined them when she wrote in a note to investors. “Weak US demand in core categories and rising raw material costs set the stage for tepid domestic beverage profits in 2007, while emerging market growth remains robust.” She then raised Coke to a buy form neutral, “as its turnaround begins to get some traction”. She continued, “recent results demonstrate Coke’s ability to weather challenges in key developed profit centers and still deliver strong global profit. Improvement in developed markets, joined with continued robust growth in emerging markets, should help sustain solid results and help close the [price/earnings] multiple gap versus other high-quality global consumer staples stocks.” She at least was smart enough to not put a price tag on shares. If we go to the earnings conference call on 2/14 we can see Ms. Hong savagely grilled management with questions like this: “One segment where you didn’t gain share globally last year was ready-to-drink coffee and tea, and I guess some of that is because of the weakness in Georgia Coffee in Japan. Can you also talk about just broadly what you’re doing to improve your performance in that segment especially in markets like North America where you have been lagging competition?” “Talk broadly” ?? Are you kidding me? Here is the translation: “My boss might be listening so I have to ask a question, just give the corporate PR line on this and we’ll call it a day, besides, it is almost lunch time.” How can you actually “analyze” something by only getting “broad” information and then making a decision to tell people to buy the stock the following day with no additional details?
On its face you might read the reports and say “Hey 19% and three buy recommendations? Let’s jump in and buy shares!!” But before you do, lets take a closer look at July 2004 because after all, how can we know where we are going if we do not know where we have been?
July 2004 Coke Share Priced at $50
2004 Earnings Per Share $2.14
2004 PE ratio 23.3
2003 EPS $1.95
EPS Growth 9.7%
What is one of my most fundamental rules of investing? Never pay twice the growth rate for a stock. Especially one growing at a blistering 9% (see previous Coke post for my evisceration of management for this “goal”). In 2004 investors buying Coke paid 2.4 times the growth rate for shares. That is the reason shares have not gone anywhere, period, end of sentence, case closed, go home & turn out the lights the party is over and Colonel Mustard killed Mrs. Plum in the library with the candlestick. Now, the “analysts” want us to think Coke is in store for 19% share price appreciation? It must be that Coke’s situation has changed? Let’s do a little home work and look at some more numbers:
Current share price $47.5
2006 EPS $2.22
2006 PE Ratio 21.3
2005 EPS $2.05
EPS Growth 8.2%
So the lemmings want us to believe that paying 2.5 times earnings growth in 2007 will result in a 19% gain in the stock when for the past 3 years these same numbers have lead to a stagnant share price? How can they think this especially when you consider that Coke’s own executives have no goals or desires to grow more than 7% to 9% annually so it isn’t like we are in store for 15% EPS growth this year? For some inexplicable reason they must think the rules of investing will change? But wait, let’s look closer at Coke’s history. It is possible that the current situation is just an aberration and that is the reason for the blindly optimistic outlook. Maybe, just maybe when Coke has experienced similar financial metrics in the past, shares have appreciated. Let’s go back to even farther to 2001 to see how we got here.
2001-2006 Annual EPS Growth 8.2%
Average PE Ratio 26
PE to Earnings Growth Average 3.1 times
These numbers show us that Coke’s current numbers are essentially the same as its historical averages since 2001. We can now say with some degree of confidence that whatever has happened to the price of the shares in the last 6 years, we can reasonably expect that trend to continue. Why? The market has been presented with these numbers for Coke on a regular basis in the past and put a price on Coke shares based on them. So here are the results:
Jan, 2001 Share Price: $60
Current: $47
Uh Oh…. When faced with similar financial metrics since 2001, shares of Coke have lost about 21%, yet the “analysts” are calling for shares to rise 19% now! It is beyond my ability to comprehend how they can look at the results from 2004 to 2007 in their reports and based on the history above conclude anything but more of the same for Coke’s share price. Maybe they have never heard of Ben Franklin?
Don’t these people have a duty to do a legitimate job analyzing companies before they recommend them? How can you look at the above numbers, come to the obvious conclusion that the current situation at Coke is virtually identical to what it was in 2001, 2002, 2003, 2004, 2005 and 2006 and conclude, “things will be different this time”? Some things in life you can count on: Popeye will always find his spinach and inflict a “Rodney King” on Bluto, the coyote will never catch the road runner, peeing into the wind is always a bad idea, wiping your butt with poison ivy is an even worse one and stocks of huge companies that only grow 8% and sell for over 2.5 times that do not go anywhere.
Oh yeah… and Ben Franklin was right…….
4 replies on “Ben Franklin Defines The "Analysts"”
I don’t deny analysts are usually lemmings. But looking at your own numbers, and how you presented them, one could easily make the case that Coke IS worth at least $57.
If you applay the Average PE Ratio you calculated (26) to 2006 EPS of $2.22 the stock price should be $57.72 or 21.5% higher than current levels. If we take your PE to Earnings Growth Average (3.1 times) x (8.2% EPS Growth) the PE should be 25.42 for a stock price of $56.43 and a premium of 18.8%.
Although I agree with most of your arguments, if you actually compare what Coke has historically been priced at, one could certainly see how it could gain 18%-20% while maintaining an 8.2% growth rate.
j,
You have it backwards, rather than going UP to those #’s, the price of KO shares has fallen FROM them. That means at a 26 pe, shares were too expensive compared to its growth rate and investors fled. There is no reason to expect they will jump up there again. Had shares risen in the last 6 years you could make your argument, since they fell, we must conclude at those lofty pe levels KO was overpriced.
Honestly, this is a pathetic analysis.
1. Why do you consider 8% growth a bad target? For a large and mature company, 8% growth would be phenomenal. Look at companies Like P&G, KO, and WWY and you’ll see that double digit revenue growth is hard to come by. If you ever think that a company will grow it’s revenue by double digits forever, you’re insane. KO produces $5B in free cash flow a year for a FCF yield of ~5%. They can grow that FCF probably at a 5% rate without incurring any additional capex on top of depreciation. Any excess capex will probably jack up the growth rate. Anyway, that 5% FCF yield is the same as the market’s FCF yield. Long run, KO should be able to grow its FCF at the same rate as the market, which would mean that KO is fairly priced.
That said, I would make the argument that KO has much less risk than the broad market and should therefore have a lower FCF yield (like an investment grade bond vs. junk). If KO were to yield only 4% FCF, that would imply a market cap of ~$130B, which would be ~20% higher than the present stock price. This is why Buffett is happy to hold KO, and why Bruce Greenwald was buying a TON of KO at $42/share. Based on this idiot’s analysis, $42 would also be too much to pay.
An analysis that uses PE divided by growth rate is totally idiotic. we will always be paying multiples of growth, and over time, the market has traded at multiple of growth. Want proof? The average S&P 500 PE over the last 50 years has been ~16. The average growth rate of earnings for the index has been ~6% annually. That’s over 2.5 times, and hey, we’ve gotten 10.83% annual returns out of that. I would say not bad.
Of course, all that is aside from the fact that PE divided by growth is just mathematically improper and ignores the reltionship between a multiple and a yield (they are the inverse of each other). A much smarter way of combining valuations and growth rates is to take an earnings yield and add a long term growth rate to it. For KO, that would mean 4.8% plus 5.5% long term growth, for a total expected long run return of 10.3%. That’s not bad compared to what Buffett has called 6-8% annual returns for the market over the next decade.
David,
In the future be mature keep your insults to yourself. Any post’s that insult either me or other users will not be used. I will answer your questions point by point….
1- 8% is a bad growth target because its only competitor, Pepsi grows at over 12% despite having 45% more revenues (does that address your “size” issue?). As for the future cash flow argument it is a good one except when you consider that not only has Coke failed to grow them 5% during the last 3 years, they have actually been negative so we will have to eliminate that point of yours.
Buffet is not happy holding Coke, he has said many times he wished he sold in 1999-2000. He holds it because split adjusted he is in at about $5.75 a share, when you consider the $1.24 dividend he earns 21% a year on his invested $$. Yes, $42 would also be too much to pay.
I also am fully aware we pay multiples over price, you are talking price and I am talking value. They are apples and oranges. Since we are quoting Buffet, he says “price is what you pay, value is what you get”.. remember that. Comparing the market to a single company is also disingenuous. The market gets a higher multiple because its earning growth is about as stable as you can get, Coke’s is not and for proof just go back to 2005 when earnings actually FELL. The S&P is a great investment, but we are trying to beat that.
Your last point is obtuse and I think on purpose. You cannot just add the earnings yield and growth rate together. What you just said was 4.8 %+ 1.055 (5.5% growth) = 10.3%. Done properly the answer is 5.06% … and no that is not good. Fuzzy math?
Do yourself a favor, run a stock screen and make the PE parameter 15 and under and the growth rate the same. The results may just shock you. One more thing, if my “analysis is so “idiotic”, then why have the price of Coke shares behaved precisely the way I say they should based on it? Or another way to look at it is, if yours is correct, then why are shares down over 20% the past 6 years? Coke’s financial metrics are essentially the same. I will save you the trouble, they were and are overpriced.
Say what you want kiddo but if you are a buyer of Coke here you’d be advised to heed the advice of Jim Croce, “don’t pee into the wind”.