Investing in companies with powerful brands is a proven way to grow wealthier over time. That’s because these businesses enjoy greater pricing power than others — and that helps revenue, profits, and dividends to steadily move higher.
This investing strategy has quite literally paid dividends over the years for Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) and its chairman and chief executive officer, Warren Buffett. Among his favorite positions is Coca-Cola (KO -0.47%). Berkshire’s $23.5 billion stake in the beverage giant is a top-five holding, representing 7.3% of its massive investment portfolio.
But is the Dividend King a buy for dividend growth investors after recently hiking its quarterly payment per share by 4.5% to $0.46? Let’s take a closer look at Coca-Cola’s fundamentals and valuation to find out.
The business model is incredibly lucrative
Under the leadership of Buffett, Berkshire Hathaway is especially appreciative of very profitable businesses. This is probably one of the reasons why the conglomerate opened its position in Coca-Cola back in 1994.
Unlike PepsiCo (NASDAQ: PEP) and its diversified brand portfolio across both the beverages and snack categories, Coca-Cola is solely focused on leading the beverages category. In addition to its emphasis on more profitable away-from-home channels (i.e., restaurants and hotels), this explains how Coca-Cola boasts a superior profit margin compared to PepsiCo.
Coca-Cola’s most recent net profit margin was a staggering 22.2%, or more than double its archrival’s 10.3%.
Coca-Cola’s net revenue surged 7% higher year over year to $10.1 billion in its fourth quarter, which ended Dec. 31. To combat rising costs, the company implemented price increases. Along with a favorable mix due to growth in out-of-home channels sales, Coca-Cola’s net revenue rose 12% from these two factors. Thanks to the inelastic nature of its products, unit case volume fell just 1% as a result of the increased prices.
Growth in demand for syrup from authorized bottlers led concentrate sales to inch up 2% in Q4. Coca-Cola’s acquisition of the remaining interest in its Bodyarmor sports drink brand in November 2021 gave a 1% lift to net revenue. Finally, unfavorable foreign currency translation resulting from the strong U.S. dollar was an 8% headwind.
Earnings and dividend growth can continue
For the fourth quarter, Coca-Cola’s non-GAAP (adjusted) diluted earnings per share (EPS) was flat at $0.45. Cost of goods sold increased faster than net revenue, leading to a 130-basis-point decline in the company’s non-GAAP net margin to 19.1%. Paired with a steady share count, this is how the company’s adjusted diluted EPS growth lagged net revenue growth for the quarter.
However, the average analysts’ forecast calls for 6.1% annual adjusted diluted EPS growth over the next five years for Coca-Cola.
On the dividend front, Coca-Cola’s 3.1% payout is well above the S&P 500‘s 1.7% yield, which should be refreshing to income investors. And since the dividend payout ratio is poised to clock in below 71% in 2023, the dividend seems to be quite sustainable — and that, in turn, gives the company the capital necessary to pursue growth opportunities and repay debt.
A valuation that is within reason
An examination of Coca-Cola’s business arguably reveals that its fundamentals are solid. Surprisingly, the valuation is somewhat cheap for a stock of its caliber. Coca-Cola’s forward price-to-earnings (P/E) ratio of 21.2 is just below the non-alcoholic beverages industry average of 21.3. This is why I believe that the stock is a compelling buy for dividend growth investors.
Kody Kester has positions in Coca-Cola and PepsiCo. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool recommends the following options: long January 2024 $47.50 calls on Coca-Cola. The Motley Fool has a disclosure policy.