Investing 101: Introduction :: Strategy :: In-Depth :: Wall Street

Stocks In-depth

Decision

Coca-Cola’s Checklist
Other Considerations
Buy the Stock?

Checklist — the Coca-Cola Company

Company		Yes	No
	Do you really understand the business?
	Does the company have a cost advantage?
	Is the product superior — actual or perceived?
	Are there barriers to entry in the industry?
	Is the industry an oligopoly (only a few competitors)?
	Are the company’s advantages sustainable?
Management		Yes	No
	Do the managers own a lot of stock? Are they buying more for themselves? (If they’re selling, be wary)
	Do they have a vision, and a strategy to realize that vision?
	Are they paid fairly?
	Has the stock outperformed its competitors during their tenure?
	Is the Board of Directors predominantly comprised of independent, highly capable members?
	Do you trust the management with your money? Are the managers focused on creating shareholder value?
Stock		Yes	No
	Has the earnings per share (eps) growth been stable? (last 10 years vs. last 20)
	Are eps estimates rising?
	Is the free cash flow positive after deducting dividends?
	Is the company repurchasing shares?
	Is the stock out of favor on Wall Street?
	Is the expected ROI attractive to you?

Checklist — Advanced


Company		Yes	No
	Is the pretax margin higher than its competitors?
	Has the pretax margin been rising over time?
	Has the R&D ratio been rising, as well?
	Has the SG&A ratio been declining?
	Is the interest coverage ratio above 3?
	Have accounts receivable and inventories been rising less than or equal to sales growth?
	Has sales growth been reasonably close to earnings growth?
	Have sales and earnings growth come primarily from internal growth (rather than from acquisitions)?
	Have "non-recurring" charges been few and far between?
Management		Yes	No
	Has the compensation of the top five managers accounted for < 10% of pretax income?
	Have company options accounted for less than 10% of pretax income? Has the company avoided the questionable practice of repricing options when the stock price declined?
	Is the Chairman of the Board an outside board member?
	Have there been no disagreements with or changes of auditors?
Stock		Yes	No
	Is the 10-year RORE greater than 20%?
	Has the RORE been rising (5-yr > 10-yr)?
	Is the operating free cash flow positive after dividends?
	Is the operating discretionary cash flow significant?
	Is the P-E (adjusted for goodwill) attractive to you? Relative to the average P-E of the S&P 500?

Coke’s checklist has some problems: RORE has been declining during the last decade and is below 20%, while future estimates have been lowered time and time again.

For the third quarter ended September 30, Coke reported a 13% increase in revenues on a 5% world-wide volume gain. For the first nine months of 2002, Coke reported an 11% increase in revenues on a 5% world-wide volume gain. Earnings per share (EPS), adjusted to exclude several non-operational items and currency impact, were $.49 vs $.46 in the third quarter, an increase of 7%; adjusted operating income (a better measure than adjusted EPS) rose 10% in the quarter.

The company expects volumes to increase by 5% and EPS to rise by 11% in 2002, in line with the company’s 11-12% long-term growth target. This projection, though far below Coke’s target of a few years ago, is nonetheless impressive for a company with 116 years of growth under its belt.

The company seems to be on a rocky but sustainable rebound from the difficulties created by economic weakness in the US and internationally, and by a contamination scare in Belgium. The relatively new chief executive officer, Doug Daft, has emphasized a ‘think local, act local’ strategy and a focus on improving relationships with customers, bottlers, governments and investors.

Coke is still facing a number of challenges, most significantly the unimpressive U.S. volumes in its core carbonated brands. An emerging challenge is the backlash against U.S. brands in Northern Africa and the Middle East in the wake of our anti-terrorist actions. On the positive side, the U.S. currency, which has been rising for a number of years, has declined from its peaks.

Stock repurchases, which have reduced the share base by a third since 1984, were an additional $464m in the third quarter, after being a non-factor in 2000, 2001 and the first half of this year. Free cash flow year-to-date was $2.6b, on pace to reach $1.40/share for the year; in 2001, free cash flow was $1.20/share.

The stock has significantly outperformed a dreadful stock market this year. The valuation is not terribly cheap and the results have been poor over the last 5 years but the stock deserves to be a major core holding if you’re willing to give the company the benefit of the doubt, which we are — after all, how many other companies are likely to keep posting solid profit gains from now until 2102? We estimate that KO will provide a total return approximating 10% annually over the next decade — not the stuff of dreams but almost certain to outperform stocks in general.
In the face of all these concerns, is the stock a buy? The short answer is “yes” (the longer answer is “yes, but.”). Coke is facing many uncertainties, but it a company which justifies the benefit of the doubt, both in its operations and in its leadership.