Billionaire investor Warren Buffett is making some big bets on individual companies right now. Currently, over 70% of his portfolio is invested in just five stocks.
One of those five is well-known beverages company Coca-Cola (NYSE: KO). Here, he owns about $24bn worth of stock, which equates to around 7% of his portfolio.
Should I follow Buffett and buy some Coke shares for my own portfolio? Let’s discuss.
A classic Buffett stock
I can see why Buffett likes this stock. For starters, the company owns some very powerful brands. Not only does it own the signature brand, but it also owns Fanta, Sprite, Schweppes, Powerade, and a number of other well-known beverage brands. Strong brands provide a company with a competitive advantage, or an ‘economic moat’ as Buffett likes to say, as they enable companies to capture and maintain market share.
Secondly, the company is quite profitable (a high level of profitability is one of the first things Buffett looks for in a company). This is illustrated by the fact that between 2016 and 2021, the company averaged a return on capital of around 14%. Companies that generate high returns on capital tend to grow quickly as they have significant profits to reinvest for future growth.
Third, Coke has a fantastic track record when it comes to generating shareholder wealth (another thing he looks for). Since Buffett first bought the stock (in the late 1980s), it has returned over 2,000%. And that’s not including dividends.
Speaking of dividends, Coke is known as a ‘Dividend King’. These are an elite group of companies that increased their dividend payouts for 50 consecutive years, or more.
Finally, the company still has plenty of growth potential. One area that looks set to drive growth in the years ahead is the world’s emerging markets. In developed markets, 75% of beverages consumed are commercial products. However, in the emerging markets, commercial beverages only represent about a quarter of all drinks consumed. Given that the emerging markets are home to 80% of the world’s population, there appears to be a big opportunity here.
Overall, this is a high-quality business. It’s exactly the kind of business I like to invest in myself.
Should I buy?
One issue for me right now however, is the stock’s valuation. Analysts expect Coca-Cola to generate earnings per share of $2.55 this year. It means that at the current share price, the forward-looking price-to-earnings (P/E) ratio is about 24. That’s a relatively high valuation.
Now I do think Coke deserves a premium valuation given its high-quality attributes. However, a multiple of 24 is just a bit too high for me. In my view, buying at that valuation could result in underwhelming returns in the short to medium term.
So what I’m going to do is put Coke on my watchlist and keep an eye on the share price and valuation. If the P/E ratio comes down to near 20, I’ll consider buying the stock for my portfolio.
