When Aaron and I were at the World of Coca-Cola in Atlanta, we thought about buying our niece and nephews some gifts from the retail store but ultimately decided to give them something more valuable: Stock. We’ll make another transfer to the custodianships I setup last year, modeled partly after the one we established for my youngest sister more than a decade ago.
We planned on getting everyone Coke stock but the more we talked about it, we decided to make a single exception. Our niece will be getting equity in PepsiCo, instead, following the Great Betrayal last October when she informed us that she preferred it over the glorious Southern nectar that is clearly superior in every conceivable way. Genetics are to blame. My brother is the same way. They take after their great grandfather, who would drink it for breakfast. I’m living amongst heathens.
This got me thinking about the power of the Pepsi empire and its deceptively understated historical performance due to some corporate reorganizations that happened back in the 1990’s. (Though, you wouldn’t know it if you checked Yahoo! Finance, which, I’m now convinced is being run on auto-pilot. We’ve already discussed the fact it has some fairly significant errors, like calculating the dividend yield incorrectly from time to time, or using a short-handed programming method to estimate historical dividend-and-split-adjusted share price that leads to some really wonky results once you get out past 10 or 15 years in the case of high return companies, but it’s really out there this time. In rare twist from the usual, the financial portal overstates Pepsi’s performance in the time frame I’m going to discuss by understating the historical cost basis. They really need to improve their data feeds because spin-offs just do a number on the results under certain circumstances.)
Buying ~$100,000 Worth of PepsiCo Shares 32 Years Ago
Imagine on the day I was born, a successful doctor or attorney wanted to invest ~$100,000 in the maker of Pepsi-Cola. The firm, PepsiCo, was about to engage in a brutal cola war with Coca-Cola that was so knock-down, drag-out vicious, there was a point where the company was unable to raise its retail prices by inflation for more than a decade. Despite giving it their all, in nearly every market on planet Earth, Coke was able to wrestle the number one spot away from the New York company’s soft drink; a soft drink that began its early years in near bankruptcy, offering twice as much volume for the same price, and being served in washed, recycled beer bottles to save capital.
On the day I was in a Missouri hospital taking my first breath, PepsiCo closed at $44.38 per share. If our doctor or attorney purchased 2,300 shares, he’d have been out $102,074 plus a commission. Let’s imagine he then sat on his behind and did nothing for the next 32+ years. As his company grew, the board of directors split the stock as follows:
- 3-for-1 split on May 28th, 1986
- 3-for-1 split on September 4th, 1990
- 2-for-1 split on May 28th, 1996
Today, he’d open his brokerage account to find 41,400 shares of PepsiCo with an adjusted cost basis of around $2.4655 per share*. The stock has a market value of $99.00 per share as of the close of the NYSE this afternoon. That’s $4,098,600.
Equally as delightful, over that time period, he collected cash dividends of roughly $460.08 per share on the original 2,300 shares, or $25.56 on the split-adjusted equivalent. That means he’s been sent checks from Pepsi-Cola worth around $1,058,184. That was cash he could have saved, gifted, donated, reinvested, or spent for his enjoyment.
On top of this, he finds that back on October 6th, 1998, PepsiCo decided to divest itself of the restaurant group it had assembled after its cola customers felt like it was competing against them, causing problems with relationships and trust. It wrapped KFC, Taco Bell, and Pizza Hut into a company called Tricon Global Restaurants, Inc., and jettisoned it off, giving PepsiCo shareholders 1 share of the new business in exchange for every 10 shares of Pepsi they held. At the time, our investor would have received an initial block of 4,410 shares.
Tricon Global Restaurants grew, too. It renamed itself Yum! Brands, and split the stock twice:
- 2-for-1 on June 18th, 2002
- 2-for-1 on June 27th, 2007
This means he’s sitting on 16,560 of Yum! Brands shares, which have a current market value of $1,354,608.
Again, on top of this delightful outcome, Yum! has paid out growing cash dividends of its own over the years. To date, he’s collected $148,709 before taxes from his share of the chicken, taco, and pizza earnings that were distributed outright to stockholders.
Our investor finds himself, then, with a grand total of $6,658,859.
With no dividend reinvestment, and before taxes, every $1.00 he put to work back in the early 1980’s has blossomed into $65.24. Meanwhile, over this same time period, the value of a dollar bill has lost 59% of is purchasing power as Congress perpetually overspent the tax revenue it raised. (This should immediately make you realize how further understated the wealth creation was because a lot of those early dividends had much more utility than it would seem under this analysis in terms of what he could have bought with them.)
It was a fantastic outcome; one every investor should be ecstatic to experience. To enjoy it, though, you had to suffer volatility. On multiple occasions, as investors like Charlie Munger are fond of pointing out, you’d have watched the market value of the position decline by huge amounts.
One such instance: On Friday, October 16th, 1987, you’d have gone to bed with 6,900 shares of stock boasting a market value of $33.25 per share, or $229,425. When the market opened on Monday, one of the worst crashes in recorded history occurred and you watched your holdings fall to an intra-day low of $21.50 per share, giving your stake a market value of $148,350. Before you knew what was happening, $81,075 of your Pepsi wealth, or more than 35%, seemingly evaporated into thin air. It was an illusion for the true long-term owner – Pepsi was still selling Pepsi and generating a lot of profit it was going to mail out to owners, especially relative to invested capital; the sign of a good stock to buy for the long-term – but unless you could remain level-headed and rational, you might have done something stupid like accept the low bid and part with your ownership.
(The craziness of that never gets old to me. If you bought a car, and someone came up to you and offered you 2/3rds of the car’s value, you wouldn’t accept it under most circumstances. The same for a house. The same for an apartment building. And a farm. In many cases, even a senior secured mortgage bond or raffle ticket. People do it with business ownership, though, if there is a quoted market price. They hardly ever seem to repeat this follow with privately held companies. I suspect it is because a vast majority of individual men and women who buy stocks don’t have a bloody clue what they are, how to value a proportional interest in a firm, or what how to properly construct a portfolio to survive all seasons and environments. They look to the market price for validation of value, rather than as a bid or ask of which they can take advantage for their own purposes.)
For those who acted like the company was a private family holding, Pepsi and its corporate scion returned the favor with a compounding rate of approximately 13.7% per annum. The management team did all the heavy lifting. Our investor made no major decisions. He reinvested none of his cash dividends. He completely ignored his ownership. The amount of time and emotional energy he devoted to worrying about the business was next to nothing. Yet, here he is, in 2015, sitting on a pile of stock certificates representing equity in two very good enterprises, both of which are sending him a stream of direct deposits throughout the year.
How did Pepsi achieve these remarkable results? The folks in Atlanta, who were running Coke, kept destroying them on the soda front so they decided to play in a different sandbox, using Pepsi’s formidable earning power to buy some of the largest snack brands in the world as well as assemble the now-separate restaurant group. It owns everything from Lay’s Potato Chips to Quaker Oats oatmeal. They scrounged, jostled, leapfrogged, elbowed, and clawed their way to ever-higher earnings, refusing to cede ground to their arch-rival. If Coke made an extra dollar from soda, Pepsi was going to make an extra dollar any way it could, even if it meant selling bean burritos. Its second-place status, while perhaps an ego bruise, was still a goldmine that showered stakeholders with gushers of money.
Sometimes, coming in second place is still winning.
The Funny Thing About PepsiCo’s Returns Is … They Almost Match Coca-Cola
Here, though, is the interesting thing. Imagine our doctor or attorney had a brother. This brother decided to buy shares of Coke over this same period, instead of PepsiCo. He also, coincidentally, put $102,074 to work. What did he end up with?
Right around $6,798,091, or only $139,232 more. It consists of:
- $5,226,509 in Coke stock (120,984 shares)
- $1,571,582 in cash dividends
The amazing thing about Coke is that it did this by sticking to what it does best … selling beverages. Coca-Cola. Orange juice. Water. Tea. To repeat an oft-quoted point from the regulatory filings, it holds a 3.5% market share on all liquid consumed in any given day, including tap water. The brand and distribution network was so powerful, so incredibly profitable, that it didn’t have to deviate from what they had always done (gone are the days when it counted movie studios and shrimp farms as assets on the balance sheet). Coca-Cola manufactures the magical syrup and it all but prints money. It bottles liquids, marks them up hundreds or thousands of percentage points, distributes them to the furthest reaches of the planet, and sells the stuff for a price so cheap that practically anyone can afford a moment of refreshment. Its latest foray is into protein-heavy, low-sugar milk.
What’s the point of all of this? Aaron is concerned about giving different stocks to the kids. He leans toward making comparable gifts, of comparable shares, at comparable times so the end results are roughly equivalent. If any one of them ends up with ownership in something like a modern day Microsoft**, even in a tiny amount, the results would seem so terribly unfair that it could cause some conflict a few decades from now. That means it might be wiser to eventually merge all of these custodianships into a family limited partnership so they all hold membership units in a pooled basket of securities rather than individual brokerage accounts.
I’m not entirely sure disparate outcomes are a bad thing. If anything, it would be one more lesson that a single good decision, or lucky break, can change your life. “Then again”, I think, “if I were doing this for our kids, and not across multiple family units throughout the family tree, how would I behave?” I’d consolidate.
It’s a tricky thing; treat them as individuals, or treat them as part of a group with a shared identity? I think the individual approach might be better for this small amount of capital so they can take possession of it all on their 21st birthday and do what they want with it. There’s nothing stopping us from creating another, second, separate portfolio at some point in the future. Is it really some tragedy if one of the kids reaches adulthood and has $25,000, while another has $154,000? That’s life.
* The actual taxable cost basis would be different as the spin-off of what is now Yum! Brands would have resulted in some of the initial outlay being assigned to the Yum! stock, instead, while being deducted from the PepsiCo position but that is beyond the scope of this post and doesn’t change the economic consequences.
** To give you a roughly equivalent idea, Microsoft wasn’t public on the day I was born. Had an investor, instead, stuck the $102,074 in a typical money market account for several years at then-market-interest-rates, biding time until the IPO on March 13th, 1986, while assuming no dividend reinvestment, he’d be sitting on 1,467,634 shares of stock at $43.88 per share for a total market value of around $64,399,780. He’d have received roughly $14,632,311 in cash dividends along the way. That’s a grand total of $79,032,091. Even a token amount added to a given portfolio – a mere 1% or 2% – would have had a profound effect on the compounding rate because it was so extreme in its wealth creation.
Footnote: Going forward, as of today, our PepsiCo investor could expect to enjoy $135,626.40 in cash dividends per year from his holdings. Of this, $108,468 comes from a $2.62 dividend on 41,400 shares of PepsiCo and $27,158.40 comes from a $1.64 dividend on 16,560 shares of Yum! Brands. In utility terms, it means he’s receiving what amounts to $11,302.20 per month in cold, hard, cash that gets direct deposited into his account. Our Coca-Cola investor, on the other hand, is being showered with $159,698.88 in cash dividends per year from the $1.32 annual dividend he receives on his 120,984 shares of Coke. That works out to the equivalent of $13,308.24 in monthly income being sent his way from Atlanta, Georgia.