Why Is Google Valued More Than Coca-Cola?

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KO: The Coca-Cola Company logo
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The Coca-Cola Company

Both The Coca-Cola Company (NYSE:KO) and Google (NASDAQ:GOOG) are top dogs in their respective fields, commanding a dominant position and strong brand recognition. A comparison between the two companies reveals that while the market capitalization of Google is 2.15x that of Coca-Cola’s, the free cash flow (2014 figure) for the former is 1.31x that for the latter. The market is valuing Google more, as is also clear by the difference in the P/E ratio for the two giants, 24.5x vs. 20.5x. The Google stock is slightly more expensive than the Coca-Cola stock. But why?

Coca-Cola and Google are in different businesses with different growth prospects. Coca-Cola is the market leader in the liquid refreshment beverage market, but mainly operates in the carbonated soft drinks segment (CSD), which represented 73% of the company’s net volume sales last year. This segment is, however, declining. Coca-Cola has looked to dabble in new beverage segments such as milk and energy drinks, but despite strong growth in budding beverage segments, net income has declined in the last couple of years as the business is still hugely dependent on the reeling CSD division.

We estimate a $43 stock price for Coca-Cola, which is above the current market price.

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See our full analysis for Coca-Cola

Operating income for Coca-Cola fell 5% in 2014, and with the company going through what it calls a “transitional period,” revenue and net income growth might remain limited in the near to mid term. The company is focusing on improving its operating performance in North America, looking to refranchise its bottling territories in the region, in a bid to move away from the capital intensive and low-margin business of distribution. In addition, the company could derive growth from emerging markets in the long term. However, as of now, volatile macroeconomic conditions in some of the developing nations and negative currency translations are constricting growth for Coca-Cola. Also, the fast growing beverage segments such as sports and energy drinks, ready-to-drink tea, and even coconut water, are still relatively nascent, contributing only a small amount to the net revenues. Robust growth in these segments also does not guarantee growth for Coca-Cola, which faces stiff competition from the likes of PepsiCo, Nestle, Red Bull, and Dr Pepper Snapple.

On the other hand, the market sees more growth opportunities for Google. The internet search engine market might be subject, however,  to technology disruptions, which essentially attaches more risk to Google. However, the growth prospects for the company also seem brighter at present. Google’s market share in PC and mobile search markets is over 60% and 85% respectively. With growth of businesses around the world and a subsequent increase in marketing and advertising spends, the advertising market could keep growing. The worldwide advertising industry is expected to grow by 6% over 2014 to $592.43 billion this year. Moreover, the market share of digital media advertising is expected to grow by 5 percentage points by 2017 to 33.5%. [1] Google’s strong share in digital advertising, and in particular the mobile search market, bodes well for the company, as this segment is expected to witness the highest growth.

We currently have a $547 price estimate for Google, which is within 1% of the current market price.

Click here to see our complete analysis of Google

There is, of course, more risk in the technology sector compared to the beverage sector, which makes Google’s business growth relatively more uncertain. However, based on the current scenario, Google’s profits and free cash flow are expected to grow at a faster rate than that of Coca-Cola’s.

Coca-Cola has a dividend payout ratio of 0.75, which grew from 0.58 is 2013. On the other hand, Google does not give out dividends. The nature of investors for both these companies are different. Risk averse investors tend to stick with the stable, high dividend-paying Coca-Cola stock. But although the company’s dividend payout and free cash flow grew last year, the net income decreased. This could reflect an underlying weakness in the company’s operations, which could continue in the coming years.

The capital structure for the two companies is also different. Coca-Cola has approximately $42 billion in debt, while Google has a minimal debt, with most of its assets financed by equity. A higher proportion of equity and a higher return on equity is why Google’s discount rate is more than that for Coca-Cola. Google has 1.3x the free cash flow for Coca-Cola, and with this amount being discounted at a higher rate, the valuation for the former should have been lower. But the market capitalization for Google is in fact 2x that of Coca-Cola’s. Investors are paying a premium for Google, which might be reflected in the strong future growth expectations for the search engine giant.

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Notes:
  1. Advertisers Will Spend Nearly $600 Billion Worldwide in 2015 []