🥤Business Overview

🎯Key Metrics

Total: 9/17

• +2 ✅ Projected Operating Margin: 33.55%
• +0 ⚠️ Projected 5-Year Revenue CAGR: 4.55%
• +1 ✅ Last 5-Year ROIC: 16.07%
• +1 ✅ Estimated Cost of Capital: 6.88% (less than ROIC)
• +1 ✅ Last 5-Year Shares Outstanding CAGR: -0.17%
• -1 ❌ Projected 5-Year EPS CAGR: 7.81% (given the ease of manipulating earnings metrics, sub-10% growth warrants caution)
• +0 ⚠️ Projected 5-Year Dividend CAGR: 5.55%
• +1 ✅ Moody’s Rating: A1
• +2 ✅✅ Morningstar Moat: Wide
• +2 ✅✅ Morningstar Uncertainty: Low

Coca-Cola has a wide moat reflecting in its stellar operating margin above the ~30% mark. The fact that the business has an overall low uncertainty and its capital allocation manages to return (ROIC) almost 3 times its cost of capital makes us have confidence in the management of this company.

However, the fact that its growth is modest with a revenue growth around the economy growth warrants some caution for the next couple of years. Despite this, it is justified by the stage of maturity this company is in during its lifecycle.

Let’s value the company, to see if its current price is justified.

📈Business Valuation

To calculate the intrinsic value of the company I’ll use multiple methods:

• Discounted Cash Flows (DCF) – Intrinsic value is estimated by projecting its free cash flows over the next 10 years and discounting them to present value using the estimated cost of capital;
• DDM (Variable) – the fair value is estimated by projecting the dividend payments across the following years and discounting them to the present value using the estimated Cost of Capital;
• EPS Growth – the fair value is estimated by projected the Earnings Per Share CAGR for the next 5 Years and then, given its current and historic values of PE, come up with a PE for the 5th Year. This will give us its price 5 Years from now using the formula: Price = EPS x PE that we then discount using the estimated cost of capital;
• Historical P/S – we assume mean reversion to the historical P/S values;
• Historical Dividend Yield – we assume mean reversion to the historical dividend yield;
• Historical P/B – we assume mean reversion to the historical P/B values;
• Historical EV/EBITDA – we assume mean reversion to the historical EV/EBITDA values.

Cost of Capital

I’ve used the latest annual financial statement of the company, the 10-Year US bonds as the risk free rate and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity. Also, given the fact that Moody’s provided a rating for the company I used it as the debt rating.

Cost of Capital: 6.88%.

This value will be used later as a discount rate in the valuation methods.

Please feel free to come up with your own values by using the tool I’ve used: Cost of Capital – The Fair Value Journal. It is and will ever be completely free 🙂

Discounted Cash Flows (Weight: 25%)

I’ve used the latest annual financial statement of the company, the analyst estimates for both revenue and margins and the cost of capital calculated previously.

Some notes on the inputs above:

• Terminal Revenue Growth – I’m using the risk-free rate (10-Yr bonds of US), because long term the company should not grow more than the rate of the economy. I’m using the risk-free rate as a proxy to it, so the terminal growth becomes it.
• Terminal Cost of Capital – I’m assuming the cost of capital converges long term to the industry average.
• Terminal Tax Rate – I’m assuming here that the tax rate converges to the industry average.

All the other inputs were taken from the financial statement or from analyst projections.

The DCF gives us an estimated fair value of 54.69 dollars for Coca-Cola.

Something that we can also do now is to play around with Monte Carlo simulations. What this will allow us to do is to simulate multiple DCF valuations with pre-defined ranges for each of the inputs. Each simulation will randomize the inputs between these pre-defined values. For this I also used analysts estimates.

As you can see from the above Coca-Cola seems to be overvalued given that its current price of 78.67 dollars is well above P90. From these simulations we can extrapolate that there’s more than 90% probability that the stock is overvalued at the current price.

Please be free, as before, to fill in your own values. Make the valuation your own and do yourself a DCF valuation using your own assumptions: DCF – The Fair Value Journal

DDM – Variable Growth (Weight: 25%)

Now we look at a Dividend Discount Model (DDM). This will allow us to value the company, using its dividend payments and the overall growth of it. In this type of DDM we’ll set the dividend to grow at an initial rate that then over time moderates and declines to a given terminal stable growth that will be maintained “forever”.

For the stable growth, I normally use the growth rate of the economy the company is based on, namely the 10-Year bonds of the currency used by that economy country. The same as before, here we’re using the 10 Year bonds of the United States.

As you can see below I started the dividend growth at 5.55% (analysts expectations) and then slowly the growth moderates to 4.09% (the risk free rate – 10-Yr bonds of the US). Also note the use of the Cost of Equity, calculated previously when we also calculated the Cost of Capital.

Why use Cost of Equity and not Cost of Capital as the discount rate for DDM? Its because dividends are paid to equity holders after debt obligations. Since DDM values equity-only cash flows, we use an equity-only discount rate (the Cost of Equity).

Then, as always, we can also use a Monte Carlo simulation to dive deeper into the valuation 🤓

As you can see from the above Coca-Cola seems to be fairly valued or at most a little overvalued given that its current price of 78.67 dollars a little below P80. From these simulations we can extrapolate that there’s around 80% probability that the stock is overvalued at the current price and around 20% probability that the stock is undervalued.

As always take this single output, from this DDM valuation method, with a grain of salt. Let’s move on to the other valuation methods to get a clearer picture.

Please be free to use the same free tool I’ve created here: DDM (Variable) – The Fair Value Journal

EPS Growth (Weight: 20%)

For this valuation method, I’ve used the current EPS and the analysts estimates of EPS growth. I also assumed a 24 PE for the company, so a little below its current value.

Then again, I used the Monte Carlo simulations to check how the estimated fair value changed as my assumptions were modified.

Using this valuation method, Coca-Cola that is currently priced at 78.67 dollars seems to be overvalued being currently valued a little above P90. From this we can extrapolate that there’s more than 90% probability that the stock is overvalued.

As before, feel free to try this yourself: EPS Growth – The Fair Value Journal

Historical P/S (Weight: 10%)

The current P/S (Price / Sales) ratio is above its 10 Year average. This means that the company is overvalued by this metric. Assuming a mean reversion to its historical average of 6.01 we can assume a fair value of 64.93 dollars.

For every type of historical and relative valuation you can use the same free tool: Historical / Relative Valuation – The Fair Value Journal

Historical Dividend Yield (Weight: 10%)

The current Dividend Yield ratio is below its 10 Year average. This means that the company is overvalued by this metric. Assuming a mean reversion to its historical average of 3.02% we can assume a fair value of 67.47 dollars.

Historical P/B (Weight: 5%)

The current P/B (Price / Book) ratio is around its 10 Year average. This means that the company is fairly valued by this metric. Assuming a mean reversion to its historical average of 10.91 we can assume a fair value of 81.48 dollars.

Historical EV/EBITDA (Weight: 5%)

The current EV/EBITDA (Enterprise Value / Earnings Before Interests, Taxes, Depreciation and Amortization) ratio is above its 10 Year average. This means that the company is a little overavalued or even fairly valued by this metric. Assuming a mean reversion to its historical average of 24.00 we can assume a fair value of 75.39 dollars.

✍️Summary

Now that we did all the heavy work, let’s take the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values:

Feel free to choose your own values, but for me I will start buying Coca-Cola shares around the 64.43 dollars, given the wide moat, premium brand and overall stability and low uncertainty of its brand.

Overall it seems Coca-Cola is overvalued at the current prices.

Fair Value: 69.52 dollars