The Coca-Cola Company (NYSE:KO) is scheduled to announce its second-quarter (Q2) earnings on Wednesday, July 26. Analysts are anticipating an earnings per share (EPS) of 72 cents on revenue of $11.73 billion. If Coca-Cola meets these expectations, it would represent approximately 3% growth in EPS and 4% growth in revenue. It’s worth noting that rival company PepsiCo (PEP) recently reported strong earnings, surpassing expectations with the help of organic sales.

Looking back at Coca-Cola’s first-quarter (Q1) earnings in April, the stock was given a “Hold” rating. Since then, the stock has experienced a decline of nearly 6%, while the S&P 500 index gained 9%. Despite the overall positive market performance this year, Coca-Cola’s stock has declined by over 3% (excluding dividends). This price action doesn’t come as a surprise, considering that investors have been more inclined to pursue growth and risky assets in 2023 compared to the previous year. However, this presents an opportunity for long-term investors to accumulate shares in stable companies like Coca-Cola, which outperformed the market and average technology stocks in 2022.

There are three main reasons why Coca-Cola should be considered a “Buy” heading into Q2 earnings. Additionally, a key metric to watch in the company’s earnings report will be discussed. Let’s delve into the details.

Reason #1: 3% Yield

Although Coca-Cola is renowned for its dividend growth, it has rarely been a high-yielding stock. The stock’s price tends to increase each year as the dividend is raised, leading to a gradual catch-up effect with increasing dividends over time. For instance, 10 years ago in 2013, when the annual dividend was $1.12, a 3% yield was equivalent to a stock price of $37.33. Fast-forward to 2023, with the current annual dividend at $1.84, the 3% yield would correspond to a stock price of $61.33. Throughout this time period, except during the COVID-related lows, Coca-Cola’s stock has seldom yielded above 3%. This indicates that the stock price adjusts gradually with rising dividends.

For a longer-term perspective, examining a 35-year yield chart reveals that Coca-Cola’s yield has rarely exceeded 4%, with two notable exceptions during the 2009 financial crisis and the COVID-19 pandemic in 2020.

Reason #2: Positive Correlation with PepsiCo

Despite being rivals, PepsiCo and Coca-Cola tend to benefit from favorable market conditions together. PepsiCo’s recent strong performance suggests that Coca-Cola may also report positive results. While they compete, both companies have deep-rooted core consumers, meaning that PepsiCo’s success is unlikely to come at the expense of Coca-Cola. In the past, strong organic sales numbers have propelled Coca-Cola’s stock higher. PepsiCo’s recent report highlighted a 13% organic sales growth in Q2 and a projected 10% full-year organic revenue growth compared to an 8% estimate.

Reason #3: Technical Indicators and Oversold Condition

Coca-Cola’s stock currently has a Relative Strength Index (RSI) of 37, indicating that it is nearing an oversold condition according to textbook definitions. However, there is an encouraging sign for technical analysts as the stock has just reached its 200-Day moving average, suggesting a potential relief rally or even a sustained uptrend if the upcoming earnings report is positive.

When assessing dividend safety, the author of this post emphasizes the importance of Free Cash Flow (FCF) over Earnings Per Share (EPS). While Coca-Cola’s payout ratio based on EPS appears comfortable at 70% (considering an expected annual EPS of $2.61 and a current annual dividend of $1.84), recent FCF trends raise concerns.

Despite the 61st consecutive annual dividend increase announced by Coca-Cola in February, FCF continues to be a point of concern. The Q2 earnings report will be closely watched for updates on FCF, as the company requires approximately $2 billion in average quarterly FCF to meet its dividend commitment to shareholders, considering the total shares outstanding and the current quarterly dividend.

The recent developments surrounding the impact of Aspartame on Coca-Cola and PepsiCo should be monitored. However, given Coca-Cola’s resilience throughout its long history and the company’s ability to overcome challenges, particularly in relation to Diet drinks, now might be an opportune time to initiate or add to your holdings. There’s a potential win-win scenario where a strong Q2 report could drive the stock price higher, benefiting from current undervalued/oversold conditions. Alternatively, if the stock sells off, it presents a rare opportunity to acquire shares at a historically scarce yield point over the past 35 years.