Case Number 1: Valuing Coca Cola Stock. Executive Summary The Coca Cola Company, founded in 1886 in Atlanta, Georgia, is the premier soft drink producer globally. Besides manufacturing the famous Coca Cola, the company is responsible for bringing a variety of different products to the global market such as Fanta, Sprite, PowerAde, Dasani and Nestea. The Coca Cola Company is divided into two main sectors: the North American Business Sector and the International Business Sector.
After selling its concentrates to the different bottling manufactures, Coca Cola frequently took an equity stake in the bottling companies whenever the firms had trouble financing their businesses. Between 1981 and 1998, Coca Cola’s dividends as well as their earnings per share increased significantly each year. This trend is predicted to continue through 1998. In order to closely analyze and predict Coca Cola’s standing in the stock market within the next five to ten years, we looked at the Dividend Discount Model (DDM), the Capital Asset Pricing Model (CAPM) and the Price/Earnings Multiple.
Based on these three calculations, we wish to determine the profitability of Coca Cola’s stock and ultimately advise Jessie’s clients to either purchase, sell or hold their existing Coca Cola stocks. Methodology In order to find the future stock price of Coca Cola, we will be analyzing the Capital Asset Pricing Model (CAPM), the Dividend Discount Model (DDM) and the Price/Earnings Multiple method. 1. The Capital Asset Pricing Model (CAPM) illustrates the relationship between expected return of the market and the non diversifiable risk.
The CAPM is used to determine the required rate of return for Coca Cola stock. 2. The Dividend Discount Model (DDM) shows the value of a firm’s present value of expected future dividends. In other words, the future dividends are discounted back to the present value. The formula takes the dividend per share for next year and divides it by the required rate of return found above minus the dividend growth rate. 3. Price/Earnings Multiple shows the price an investor is willing to pay for a given stock for each dollar of earnings.
Hence, a higher Price per Earnings ratio usually means that the firm has prospects of growth. Summary of the results: see attached Excel sheet. 1. Sensitive Analysis for the Dividend Discount Model Economic SituationPessimisticModestOptimistic Expected annual dividend growth11. 50%12. 00%12. 50% Evaluation of the Coca Cola Stock$33. 75$45. 93$74. 12 2. Using the P/E Multiple method we have found a fourth price Pc4 = $68. 25 3. Weighted Average of the four assessed prices: P = $60. 11 Our Recommendations
Our recommendation will differ considering the different clients’ profile: what are their risk tolerance and their investment objectives? Currently, Coca Cola’s stock is trading at $58 per share. Based on our price assessment, we determined a price of $60. 11 which implies that the stock is undervalued by about 3. 6%. Jessie’s new clients who wish to maintain a conservative risk tolerance should either purchase Coca Cola’s stock since the stock is slightly undervalued and is projected to have a modest stock appreciation over the next three to five years (according to Value Line’s outlook).
Another factor that appeals to this type of investor is the favorable dividend payout ratio which averages 40. 8% from 1986 to 1996 and 38. 5% from 1991 to 1996. Finally, the Beta of Coca Cola stock is moderate (1. 24), so Coca Cola is not really risky because only 24 % more volatile than the market. Concerning her current clients who already bought Coca Cola and have this same investment profile, we recommend them to hold this Value Stock. However, we would not recommend this investment to Jessie’s new clients with a higher risk tolerance and a longer time frame to reach their investment objectives.
Even though the stock price dropped last month the future expected capital gains are limited. It only can be a fair opportunity of diversification for a too risky portfolio. For her current clients with the same profile we recommend selling the stock except if this action will reduce the diversification of their portfolio and therefore increase the risk or if the sale causes large capital gains with not enough capital losses to offset at least a portion of this major capital gain.