How to determine if a stock is a good investment ? The example of Coca Cola.
When deciding which stocks to invest in, we need to consider several factors.
In order to do that we use the following matrix/template which is a combination of fundamental analysis and technical analysis.
Here we will take the example of the Coca Cola stock in June 2021.
1/ Your own personal goals
Everyone is different. We may want different things or have a different tolerance to risk.
- What is your risk tolerance ? Are you looking for quick profits (and higher risk) on a high volatility investment?
- Are you trying to receive regular income from your stocks ? (dividend stocks) - in this case you may want to avoid technology stocks, with a few exceptions like IBM or Iron Mountain). Technology stocks rarely pay dividends to their shareholders but their growth in value may be faster.
- Do you want to focus on stocks with growing value?
- Do you want to build a portfolio that appreciates over time (long term investment)?
2/ The Company
- Is the company well established and solid ?
Coca Cola is a very solid company. Founded in 1892, it is one of the largest multinational corporations in the world.
Its annual revenue is around US$ 37.27 billion. Coca Cola's brand is amongst the most recognizable and valuable brands in the world.
- How does the company score in relation to its competitors ?
- How does the company compare in relation to similar companies ?
Coca Cola would have to be compared with similar soft drinks or drinks companies, but also with competing markets and more healthy alternative options.
- Is the market growing ?
Impressively, Coca-Cola has grown EPS (Earning Per Share) by 22% per year, compound, in the last three years. However its revenue have been declining in recent years.
- What is the company's potential to generate operating earnings? (EBIT) Earnings before interest and taxes, aka EBIT is a KPI of a company's profitability. EBIT can be calculated as revenue minus expenses excluding tax and interest. EBIT is also referred to as operating earnings, operating profit, and profit before interest and taxes. EBIT reflects a firm's fundamental earnings potential.
While Coca-Cola may have maintained EBIT margins over the last year, revenue has fallen.
- Is the company’s activity cyclical or relatively stable (secular)? A company is cyclical if it needs a strong economy in order to perform well. Its success depends largely on the current business cycle. Some industries (steel, machinery, chemicals) are more cyclical. In contrast some companies are more recession-proof. For example, economic cycles are known to have little or no impact on companies selling foods, drinks, drugs and cigarettes.
Coca Cola is famously secular. Usually companies who pay regular dividends over long periods of time are identified as being secular. Being labelled as a Dividend King, Coca Cola is non cyclical. This makes it a good choice for long term investors seeking steday revenue.
- Can particular future or current risks be detected, for example :
- Strategic risk,
- Loss of a large contract,
- Risk related to a big law suit (patent dispute, etc.)
- Regulatory risk,
- Disruptive new entrants threatening the company and/or its market (for example Amazon competing with brick and mortar retailers).
Coca Cola is facing competition from Pepsi, RedBull, Britvic, Danone and possible new market entrants. It is facing growing criticism from health conscious customers. There is a risk that consumers would chose more value aligned substitute products. There are also challenges to its practice on an environmental level (water pollution, water shortage in some countries, use of chemicals).
3/ The Stock
A great company does not necessarily mean that the stock is a great investment.
- Stock price? On June 10th one Coca Cola stock is value at US$55.48
- What is the stock's Yield ? (dividend paid by the company for each payment period) ?
In 2021 the Coca Cola dividend (yield) was 2.99% (US$1.66 per share)
- Compared to other stocks does the stock look overvalued or undervalued ?
- Price-to-earnings (P/E) ratio (PER) (i.e. stock price divided by most recently reported earnings per share (EPS)). A low P/E ratio means that an investor buying the stock is receiving an attractive amount of value. In contrast a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. However whe the P/E is too high, the stock is probably overvalued. P/E varies depending in the relevant industry.
Examples of P/E ratios:
- PepsiCo (PEP) (USA): 27.08
- Nestlé (Switzerland): 26.5
In June 2021 the Coca Cola P/E ratio is at 33.24. This is very high and may be an indication that the stock is currently overvalued.
4/ General status of the stock market
- Is it a bull market or a bear market ? You may hesitate to invest in the stock market in general if it looks like it is already at the top of a bull market. The likelihood is that the market and most stocks will come tumbling soon.
General S&P500 over 5 years (TradingView):
Looking at the current stage of the market any investor should be cautious.
- Look at general market trends for this stock (Fib retracement, market analysis etc.)
Taking the view on the last 5 years for the Coca Cola stock, we can see that we are now getting close to the all time high. This is probably not a safe zone to be buying.
- Run the Awesome Oscillator tool (measures market momentum)
Looking at the AO for the Coca Cola stock on June 10th, we can see that the market momentum is about to go below the zero line. The stock will probably decrease in value in the coming months... you know how it goes. Markets are cyclical...
Disclaimer: This article is based on our own experience but we are not financial advisors. Please act responsibly when investing and take proper advice form the relevant professionals.