Coke Might Not Be Exciting, But It Still Has its Place

Coca Cola

If we want to go with a stock that lags over ones that don’t, including the index itself, we should need some very good reasons to do it. Coke does have its time and its place.

The news on Coca-Cola stock is that the Street sees more upside for it in 2020. It’s hard to argue that it doesn’t. It is not enough for a stock to have more upside though, it has to have enough upside to make it attractive, or at least have some other good reason to be attracted to it.

Anyone who is looking at this stock as a potential buy or even those who already own it and are inquisitive about whether it should be held in the coming year will want to know if either is a good idea right now, or rather, if this would be such a bad idea to have us vote against it.

For those whose goal in owning Coke right now would be to seek growth, Coke simply would not be a good bet, either next year or in any year. The stock market loves potential, and Coke has saturated its potential market to a large degree, as people can only drink so much of their stuff.

Without knowing anything else, stocks with a beta of 0.5 just don’t run very fast, and cannot certainly be counted on to outperform the market when the bulls are in charge. Being slow of foot does help when the bears take over, and those who simply insist on wanting to dance with the bears may want to have good exposure to Coke and other stocks which are considered “defensive.”

While seeing your market so saturated inhibits growth, it also can provide a position in the market that is so extensive that it’s just not hard to knock down too much. This is Coke’s claim to fame, and is the real reason why some might consider it.

There are definitely concerns still out there about the potential for 2020 for the market as a whole to be a not so good year, and if it is actually a down year, then a stock like Coca-Cola reduces our risk. We do need to keep in mind though that in today’s market environment, this makes it harder to justify paying the price for a hedge like this without much need for it, so this isn’t a good idea generally.

Many people will simply favor defensive stocks without thinking very much about it, if at all, perhaps just feeling good about the reduction of risk exposure that a stock like Coke offers. Like any hedge though, if we’re simply going to hold these hedges through good and bad times, we need to at least think about how this helps and hurts and at least make a more transparent decision.

With this sort of hedge, we benefit when the market has a bad year, and are hurt when it has a good year. If the market has many more good years than bad years, and we therefore pay the price in many more years than we collect, that alone should serve to have us scratch our heads.

We Always Need to Account for How a Stock Does Over Time When We Invest

People don’t generally sit down and assess their stock positions every year though, to decide if they are in our out, and it is what happens over the number of years that we hold these stocks that really measures the effect of this. We know that the market goes up over time and as it does, we can just subtract the beta deficit from our returns and see what we missed on a net basis.

We must think of things in probabilities, and we should not be using probability against us and be so willing to pay the price for this. If the market has an up year 7 times out of 10, we need to account for this, and choosing to be wrong 70% of the time isn’t a particularly wise decision.

The only hedging we benefit with a fixed hedge is the room down to where we should exit anyway. Hopefully we are not counting on this to choose to only lose half of what others are losing when everyone simply gets pounded though. Getting punched by one fist may be better than getting hit with both fists, but it would be hoped that we would not want to just stand there and take the beating regardless.

Once we establish a reasonable point where we would just tap out, this serves to blunt the perceived need for such protection, as it isn’t helping us not fall down the well, or it should never do such a thing at least provided that we are thinking clearly enough.

The biggest reason why this isn’t such a great idea generally is that the only time it matters that a market is down is if you sell into it. The only protection that matters is therefore in the last leg, and then we need to take the amount that the stock saved us on the downside and then subtract all the upside we lost over all those years. This just doesn’t come out well.

When things do turn sour though, this changes things completely. If you are more likely to go down for a while, and you only lose half with Coke, now the odds are in your favor with this play. This involves the risk of a bear market going up enough to make one more likely than not, but still far from certain, and we may find a nice home in a stock like this while we wait for the forces to fight it out more and see a winner declared.

We can therefore cover off a good amount of risk with a defensive stock during the period between where things look gloomy enough and our exit threshold. This should be viewed in the same way as a fire extinguisher, which sits at the ready for when we need to use it. We shouldn’t be just grabbing such a thing at any random time though, when there is nothing to extinguish, and just fill our home with the fumes.

Since we do make half the average return on the way up with a 0.5 beta stock generally, we need not wait all that long after the need to hedge is established to jump in, as the price is less than with lower yielding hedging options. Coke dissolves both nails and bonds. It is up 17% this year, which is great for a hedge, even though, as expected, this is only 58% of the average.

We need to be careful when selecting defensive stocks though, as some are not that defensive and some have an offense that is all over the place and doesn’t cover as much ground.

Coke isn’t generally thought of as defensive even though it clearly is, and people tend to compare them side by side with growth stocks, perhaps even thinking that their low beta is an asset on the upside, in spite of the absurdity of this. Coke may be thought by some to be capable of magically transforming itself into a notable outperformer, and while anything is possible, don’t hold your breath.

The plan with investors who want to stay in the market in all seasons is to go with high beta stocks when the market is bullish, and then turn to lower beta ones when things do not look so rosy. Coke is a very low beta stock and is definitely one that does comparatively better during bearish times that coincide with times where we do want to be in stocks in spite of this.

One of the alternatives is to either be in high beta or not in stocks at all, as if stocks are expected to lose and some lose less, being out of stocks does even better of course. This is not as simple as it sounds though as there are times where the risk of higher betas starts to come home to roost but we aren’t at a point where we want to necessarily be out either, and this is the transition zone where stocks like Coke thrive.

We do want to be careful not to use defensive plays to defend against the real bears, perhaps taking solace in the dividends that they pay, but if a net loss is probable, we end up getting a little money put in one pocket and a whole lot more taken out of the other one. Coke for instance lost half its value during the crisis of 2008, many times more than what they pay in dividends. Anyone who thinks dropping 50% and earning 2% is a good deal needs to seriously rethink things.

We also can’t just look back and say that the best move was to hold through these crises, as many do, as this view results from real confusion as well. This is like saying that it didn’t matter if you got pushed to the ground and banged your head if you later get up. We need to always consider the opportunity cost and this plan pales in comparison to stepping aside when the fists start flying and make a whole lot money from the recovery, where you’re now not just looking to gain what was lost, you let someone else lose most of it and make a nice profit from the deal instead.

Coke Can Serve as a Very Good Hedge, At the Proper Time That Is

Coke’s beta distribution is nicely low at 0.5 to make it a good choice to use as a hedge, but even better, it is nicely skewed to the upside. This really does set it apart and makes it more desirable than your run of the mill consumer staples defensive stock, even though that doesn’t mean that this would be good to just buy and hold. It does make it a lot more tempting though should we see a need for such a thing, due to its lower cost by way of it lagging less if we are wrong, part of the risk we take on with it, as well as recovering from downturns better than its beta would suggest.

We really need to break betas down on a directional basis, and Coca-Cola is a perfect example of when it really pays to make this distinction. Coke gains a reasonably close amount to the market, but loses amounts considerably less, and behaves more like a utility than a normal stock, which is a good thing if you want to hedge.

While we may want to limit holding on to something that we may expect will, over the life of our investments, dilute our returns too much to justify the benefits of this, there are plenty of people who insist on this as they would insist on drinking Coke if they were among the massive number of people who do.

There are many others who might drink the stuff but aren’t so hip to what the stock actually does and end up choosing inferior hedges instead such as bonds or lesser stocks. We need to understand how to hedge the right way, when we misunderstand this, we not only will give up too much in returns, we may even subject ourselves to a nasty surprise. All those old folks who held a lot of bank stocks during the financial crisis of 2008 got to discover that they did not know much about hedging after all.

This is a crazy idea at the best of times because bank stocks are not the tame tiger that many may think, and can growl with the best of them, and in a recession, they simply become ferocious. Coke is a much tamer beast and by the summer of 2009, they were only down 10% from their peak in 2007. The bank index was still off its 2007 peak by 60% over three years later.

Coke’s 194% gain over the last 10 years isn’t so shabby at all, even though it trailed the broad market by 96 points. That’s two thirds of the good side, not just half, along with a staying power when the going gets tougher that few stocks with any decent upside can compare with.

Giving up all that upside speaks to doing this indiscriminately though, and situations do differ. If and when we really do think that we are headed for a correction, or even if we are fearful enough that we wish to lower our risk and get more comfortable, Coke is actually an excellent choice for this.

It is Coke’s resilience that sets it apart. If you are in a position that taking on the normal risks that stocks in general involve would be unacceptable or undesirable, the fact that it goes down less and doesn’t stay down for long makes it a very good choice in this situation and allows you to shoot for the lion’s share of the upside while keeping the downside sufficiently in check. Those who have more limited time horizons to invest can really benefit from this, allowing them to still pursue good returns while building in the extra safety that they need.

This bull market cannot last forever, and there will likely be a time where real bears and not just imagined ones come knocking, and we need to prepare for such things. Like people do when storms approach, we need a plan to deal with such events, to spot them and to act deliberately rather than out of confusion and fear, and including stocks like Coke can help us manage these things better.

If we see a new president-elect later in the year, who will at the very least be looking to depress the market and the economy with higher corporate taxes, undoing what may have been the main reason why we are keeping things together so well right now, if you even choose to stick around for such a thing, you could always have a Coke.

Andrew Liu

Editor, MarketReview.com

Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.