Taste test: Coke vs U.S. bonds

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Are investors looking at Coca-Cola Co. as though it was a U.S. Treasury bond? Eddy Elfenbein, blogging at Crossing Wall Street, makes the comparison and uses Coke as an example of how the market is over-paying for security and under-paying for risk.

Coke shares haven't exactly been lighting up the market, but they did hit a record high in July. And though they've declined since then, they are still up 7.5 per cent in 2012. More to Mr. Elfenbein's point, though, the shares trade at more than $37 (U.S.), giving them a price-to-earnings ratio of 17, based on estimated earnings. That's a higher valuation than the benchmark S&P 500.

"I just don't see how Coke can justify an above-market premium in an environment like this," he said. "Coke's earnings growth for the next five years is estimated to be 7.43 per cent, which is 2.75 per cent less than what's expected of the S&P 500."

Coke's dividend also raises questions about the attractiveness of the stock. The company's payout ratio, or the percentage of earnings given to investors in the form of dividends, is 50 per cent. That's higher than the 30 per cent average for the S&P 500. Yet, Coke's yield is just 2.7 per cent, which isn't much to get excited about.

That's why he draws the comparison to U.S. Treasuries, still widely seen as the safest investment anyone can make if they just want to get their money back. They, too, have low yields, reflecting in part a strong desire among investors to grab that rare asset that is ultra-safe and spits out regular income.

But Mr. Elfenbein's key point is that the market is mispricing safe assets – and Coke, given its global operations, massive market share, stable profitability and high credit rating, is very safe, like a government bond. He estimates the fair value for Coke shares at just $26, or a whopping 30 per cent below the current price.

However, you have to wonder if Coke only looks mispriced if you have a bullish opinion on the economy. If you suspect that the global economy is headed on a downward slope, with an ongoing recession in Europe, a steeper slowdown in China and renewed concerns about the U.S. economy, safe might be worth paying for.

That is especially true with the Federal Reserve committed to holding its key interest rate at an exceptionally low level through mid-2015, raising the comparative attractiveness of dividends.

So is Coke being treated like a bond? Perhaps. But with the 10-year U.S. Treasury bond yielding just 1.83 per cent and Coke raising its dividend by an average of 8.5 per cent a year, Coke might be the safer bet.