Coca-Cola Company (KO) may raise its dividend next month, as it typically does every four quarters. It has done this for the past 62 years. Based on its average dividend yield, KO stock could rise by over 14% to $71.92 per share. 

Moreover, existing shareholders and potential investors can make extra income by shorting out-of-the-money put options in nearby expiry periods.

This article will delve into these issues.

KO is at $62.71, which closed on Friday, Jan. 17. This is well off the 3-month high of $70.57 on Oct. 16, although up from a recent low of $60.84 on Jan. 7.

As a result, KO stock looks undervalued now, especially considering the company's strong free cash flow (FCF), which can easily finance an expected dividend hike.

Strong Free Cash Flow (FCF)

Coca-Cola reported on Oct. 23 that its net revenues fell 1% in Q3, although organic revenue was up 9%. Moreover, the company said it expects its 2024 free cash flow (FCF) will reach $9.2 billion (not including a one-time IRS payment).

That is more than enough to pay the company's dividends. For example, based on its present rate, the annual dividend costs about $8.36 billion a year:

   $1.94 Div. P/Sh x 4.307b shs o/s = $8.356 billion annual cost

That is also important since this FCF represents 19.9% of analysts' forecasts of 2024 revenue of $46.21 billion. Therefore, using analysts' 47.75 billion 2025 revenue forecasts we can expect higher FCF in 2025:

   $47.75b x 0.20 = $9.55 billion FCF 2025

That is 3.8% over the expected $9.2 billion in FCF for 2025. This shows that Coca-Cola could easily afford to raise its dividend.

Historical Dividend Yield-Based Target Price

Last year Coca-Cola raised its dividend per share (DPS) from $1.84 to $1.94, or +5.43%. Let's assume it rises by another 10 cents or up 5.1% to $2.04 annually. 

Typically that is announced in February. Coca-Cola is slated to announce 2024 earnings on Feb.11.

One way to value KO stock is to look at its historical dividend yield. Today, its dividend yield is 3.093%:

   $1.94 DPS / $62.71 price = 0.03093

For example, Seeking Alpha reports that its average dividend yield over the past 5 years has been 2.69%. So, based on this, using the new expected DPS, KO could rise by 20%:

   $2.04 DPS / 0.0269 avg yield = $75.84 target price

   $75.84 / $62.71 today = 1.2093 -1 = +20.93% higher

However, Morningstar reports that the average yield over the past 5 years has been 3.0%. That implies that, using the $2.04 DPS, the target price is +8.43% higher:

   $2.04 DPS / 0.030 avg. price = $68.00 target price

   $68.00 / $62.71 = 1.08435 -1 = +8.4% higher

Therefore, on average, the price target average is $71.92, or about 15% higher:  

   $71.92 / $62.71 -1 = 1.1469 -1 = +14.7%

Analysts Agree KO Stock Looks Cheap

For example, AnaChart.com, which tracks sell-side analysts' price recommendations, the average price target of 18 analysts covering KO stock today is $71.49 per share. That is close to my $71.92 price target.

In addition, Yahoo! Finance reports that 25 analysts have an average price target of $72.18 per share. That is close to Barchart's mean survey of $73.77 per share.

The bottom line is that most analysts see KO stock recovering. That is likely to happen once the company announces a dividend hike next quarter.

One way to play this, especially for existing shareholders, is to sell short out-of-the-money (OTM) put options in nearby expiry periods. That way shareholders can make extra income.

Shorting Cash-Secured Puts in OTM Strike Prices

For example, look at the $60.00 put option exercise price for the Feb. 14, 2025, expiry period (27 days to expiration). That put option sells for a 37 cents premium at the mid-price.

This implies that a cash-secured seller of these puts can make 0.616% (i.e., $0.37/$60.00 = 0.006167) over the next month.

This means that any investor who secures $6,000 in cash or buying power with their brokerage firm can do this trade. That money acts as collateral in case KO falls to $60.00 on or before Feb. 14. 

However, the account immediately receives $37.00 per put shorted when the investor enters an order to “Sell to Open” 1 put at that strike price. That is why the yield is 0.616%.

The point is that, especially for existing shareholders, this is an opportunity to make extra income. For example, if a shareholder can do this every month, the expected return is 7.39%.

So, on top of the 3.0% yield, the shareholder can make a 10% income. Moreover, including the 15% upside if KO stock hits the $71.92 target price, the shareholder could potentially make 25%.

Moreover, even if the stock falls to the strike price of $60.00, the result is that the investor will own shares at that price. Given the expected $2.04 dividend per share this year, the yield will be 3.4% for those investors (i.e., $2.04/$60.00).

The bottom line is that KO stock looks undervalued here. This is based on its the following:

•  strong free cash flow, expected to rise at least 3.4%
• an expected dividend hike of 5.1% to $2.04 annually
• a price target based on its average yield of between 2.69% and 3.0% of $71.92 per share
• analysts' price targets ranging from $71.49 to $73.77
• cash-secured short-put yield plays that can yield 0.62% over the next month

On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.