Coca Cola (NYSE:KO) presently has a price to earnings ratio of 27.12 which is more than 7 points off Coca-Cola’s 5-year average. In fact, you have to go all the way back to December 2007 to find the same earnings multiple when Coca-Cola stock was trading just north of $30 a share. It’s human nature to invest in rallying stocks. Coca-Cola is producing less net income and revenue at the moment (compared to 2011 for example) but its share price is almost 40% higher.
Obviously, since the market is forward looking and since the company has returned to bottom line growth ($1.24 billion in net income reported last quarter compared to $770 million in the fourth quarter of 2014), it has given Coke a higher valuation at present. The company also raised its dividend recently for the 54th consecutive year. Since so may investors have done very well with Coke down through the years, you can be sure “yield hunters” would have entered positions recently, especially after the stock has now firmly broken through its 2015 December highs.
However, many investors forget that Coca-Cola stock price actually dropped between the years 2000 and 2010 (over 2%) and the investor would only have seen a profit due to the dividend increases in that time period. In fact, a $20k investment in January 2000 would have increased to $24,399 by January 2010 resulting in a 2% annualized return. Now here is the kicker. In 2000, Coca-Cola had a much higher p/e ratio than its historic average which led to poor returns in the following decade. Could lightning strike twice? Let’s go back to 2007 when as I mentioned Coke had a similar earnings multiple (approximately 27).
If we look at the long-term chart of Coca-Cola below, we can see that it took Coca-cola stock almost 3 years to regain the $30 mark which illustrates that any investor looking to go long now must be prepared to hold the investment for a considerable period of time. Furthermore due to the high earnings multiple and subsequent drop in share price in 08 and 09, the float actually increased from 4.662 billion shares in 2007 to 4.666 in 2010.
