A Coca-Cola Christmas
You can tell what I’m studying because I become completely, totally, hopelessly obsessed with it; the recent posts about the structure of the bottlers, the biographies of past executives, the SEC disclosures, the look inside the factories, the custodial trusts for the nieces and nephews and the DRIP for my sister, the discussion of deferred taxes as a way to leverage investment returns without debt, and now, even the Christmas tree. It’s always Coca-Cola.
It’s a Coca-Cola Christmas this year in my household. If it weren’t such a hassle now that brokerage firms are getting away from stock certificates, I would have bought everyone shares of Coke and handed them out at Christmas. At least the nieces and nephews will still get some through their new custodial trusts.
Growing up, all the old people around me talked about how magical it was, so I sort of put up a block about it; “yeah, yeah … buy Coke”. My grandmother had a friend who had been purchasing it for decades – he lived in a trailer, yet unbeknownst to most around him, he was sitting on $2 to $3 million in shares at the time, if I remember correctly (I think his kids sold them when he died. If they hadn’t, they’d be worth $6 to $9 million today). Warren Buffett was up in Omaha talking about it incessantly. But by the time I was a teenager and earning my own money, the stock was at 50x earnings. That wasn’t interesting to me. How could I buy Coke at 2% earnings yield when I could earn 3x that amount parking the funds in plain ‘ole United States Treasury bills?
It’s taken nearly 15 years since the 1990’s stock bubble, but that overvaluation has largely burned off so the shares are now within striking distance of intrinsic value (not cheap by any means – I’d give them a C+ on valuation at the moment, but if they were to fall about 25%, I’d bump that up to a B+ … I’d like to see them at 13-15x earnings). In a testament to the quality of the business, even the overvalued shares during this period still handily beat inflation so you increased purchasing power by buying them at very foolish prices. So I started looking. And it’s like I see it for the first time in my life. There really is no other enterprise on the planet with this kind of economic engine. It’s hidden under all the bottler transactions and some of the other accounting, but it’s breathtaking. Magical doesn’t even begin to describe it.
I now understand why Charlie Munger has said if he were running an institutional money management business, there wouldn’t be a single account under his control that didn’t have at least some Coca-Cola. That always seemed odd to me, but it’s right there, in the numbers. I mean, I remember 10, 12 years ago sitting in Omaha during a Berkshire Hathaway meeting as they went on and on about Coca-Cola, thinking, “We get it. It’s a good business. Get on to the insurance operations.”
What was it the old hymn writer said upon his conversion and repentance, alluding to Saint Paul? “I was blind, but now I see?” It was right in front of me the whole time.
That underlying, intrinsic performance has translated into real world success. I talk about 50 years being an investment lifetime, and thinking in 25-year time periods (if you’re normal, you’ll get a bit more than two of these in your life, whereas if your parents or family members began investing for you, you’ll get to capture three or more, based on life expectancy). Let’s go back and look at half a century ago. What would Coke have done for an owner over an investing lifetime?
A 50 Year Look at Coca-Cola Shares
It’s December 10th, 1963. Coca-Cola closed at $115.62 per share on the New York Stock Exchange. Let’s say you spent your dividends along the way, so none of them were reinvested. Adjusting the cost basis for subsequent splits and cash dividends received, your net cash investment for every share of Coca-Cola would now be 32¢.
Yes, $0.32 per share. The stock opened this morning at $40.26 per share.
Let that sink in for a moment. You’d be collecting almost as much per quarter in cash dividends as your cost basis.
Nobody notices because it’s so boring; so ubiquitous; so “oh, my grandpa buys shares of Coke”. The inflation hedge inherent in the empire, both from a currency perspective and from the nature of the product, plays a big role in this. Management pays attention (according to the most recent conference call, the average cost of a serving of 8 ounce Coca-Cola at retail in the world today is $0.25. That is up over 5% from two years ago, and over 10% from three years ago, which is better than the domestic inflation rate. That means a 24 pack of 8.5 ounce Coca-Colas should cost around $6.38 at retail. It costs almost nothing to manufacture, especially once the basic volume thresholds are exceeded on the bottling operations.)
You never actually seem to see Coca-Cola making you richer, but you look back decades later and it has. It’s the most bizarre thing. It’s like General Mills in that sense.
My Christmas prayer this holiday season could best be summed us, “Dear Lord, please send us a 1973-1974 level crash event with no human mortality (contain it to the financial markets) so I can buy Coke at 5x earnings. I’ll gladly look at 75% paper losses on my existing holdings if you give me a chance to buy at those levels. Amen.”
I’ll stop talking about it soon, I’m sure, but I still have nearly every book on the company being shipped to me. Give me a couple of weeks.
In the meantime, I’m modifying my investment policy manual to state that unless the earnings yield on the Coke shares are less than 1/3rd that available on long-term Treasury bonds, they can never be sold short of an emergency or some sort of significant portfolio allocation risk scenario. Every share of Coke I buy from here on out, I hope to still own when I die (God willing) as a very old man.
I’m almost entirely certain I’ll put the stock in a stand-alone trust that prohibits it from ever being sold, and allows my children and grandchildren to only spend or invest the dividends. If the unthinkable happens and it fails, too bad. I’ve said it before, but I consider myself in the business of looking at probabilities and arranging my family’s affairs so that we have the greatest chance of benefiting from them, while adhering to our moral principles. In almost all cases, heirs who diversified away from the main money maker ended up poorer than they otherwise would have been. It turns out Milton Hershey knew what he was doing when he created the Hershey Trust Company.
The thing I find most fascinating is that most of you will read this, and then promptly dismiss it. It’s the nature of the holding. It’s almost too easy. Get back to me in 50 years.
Important Information: A lot has changed since this post was originally published many, many years ago. Among the biggest of these changes are that after 17 years, I resigned from my Investing for Beginners site. My husband, Aaron, and I, sold our operating businesses, launched a fiduciary global asset management firmed called Kennon-Green & Co.®, through which we manage wealth for other successful individuals and families including many physicians, attorneys, engineers, managers, executives, real estate developers, software developers, small business owners, and retirees, and moved from the Kansas City, Missouri area to Newport Beach, California in order to build our family by having children through gestational surrogacy.
This post reflects a work written as a personal hobby during a different period in our life when we were private investors and I had a large online following for my financial-related essays and articles. We were not actively engaged in the fiduciary asset management industry at that time. The posts may not reflect our current thinking or beliefs, conditions may have changed, and/or our analysis of a situation may be different. Any specific investment strategies, techniques, companies, securities, or investments mentioned are used solely as examples and neither they, nor any other writing on this blog, are intended as investment advice or tax advice. In both our personal and professional capacity, we may buy, sell, trade, or otherwise engage with any security at any time, including through the use of derivatives, on behalf of ourselves, our family members, and/or the private clients of our firm, without updating my past personal writings or disclosing the operation unless required by law and/or regulation. Investing can involve the risk of loss of principal, including total loss and bankruptcy. Every investor has his or her own unique considerations, circumstances, goals, objectives, and risk tolerances. You should discuss your investment strategy and/or business operations with your own qualified advisors, including your investment advisor, tax professional, such as a CPA, and/or attorney.
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Reader Comments (19)
Comments are presented chronologically, with replies indented beneath the comments to which they respond.
Paarthurnax
December 10, 2013
So I have to ask - how many times earning was KO trading at during that time?
You talk about wanting to see Coke trading at 13-15x earnings ($25-28) to find them at a good value... Looking at your net cash investment over this 50 year stretch being only $0.32 a share, I can't help but have the question pop into my mind - how much of a difference would it really make over such a long-term stretch, to pay 20x earnings?
I know, I know, "at what terms, and at what price" I realize you will get greater returns with a cheaper price, as well as a larger margin of safety. But theoretically, if your timeline is so long, what would the difference come out to be? Would it be much more than a rounding error?
Paarthurnax
December 10, 2013
Replying to Paarthurnax
By the way - are you going to get a restored vintage coca cola machine in your office as your physical representation for the company like you did with your oil trucks? 😉
Gilvus
December 10, 2013
Replying to Paarthurnax
I think Joshua should get one of the polar bears from the winter Coke commercials and keep it in his office.
That's a lot of polar bear poop and insulin, though. I'm sure the polar bears are diabetic because they drink so much Coke.
Joshua Kennon
December 10, 2013
Replying to Paarthurnax
Haha, I didn't realize I was that predictable! Hand to God, I've already shopped for them on eBay. I realized we don't have anywhere to put one at the moment so I've settled on a giant replica Coca-Cola bottle, though the antique machine is in the back of the mind. I found this beauty after dinner with one of our friends; decided to go into one of the stores on a whim and there it was.
Paarthurnax
December 10, 2013
Replying to Joshua Kennon
Haha! I was going to ask you outright if you bought one yet, but thought that'd be a bit too forward. Reason that idea sticks out to me, is because I've actually taken to copying your habit of having a physical representation of investments I own. Everything from one of my kids John Deere toy tractors that I *cough* stole, aaand yes, I have two oil trucks as well. =P
Joshua Kennon
December 10, 2013
Replying to Paarthurnax
This is the conclusion to which I keep finding myself returning. Yes, there is a point at which the price is too high, but if the business itself is one of those handful - maybe dozen or so enterprises in the world with exceptional economics that don't have much change in the core economics - as long as you're getting the Treasury bond yield or better, I think trying to get a cheap price is ultimately costly in the end.
Though it's small at the moment, I backed that conviction with my wallet. I picked up a few shares for the KRIP this month. Even though they aren't cheap, I just can't see myself being upset 25, 50 years from now for having bought them. Like you point out, the cost basis should be a rounding error.
Paarthurnax
December 10, 2013
Replying to Joshua Kennon
" Yes, there is a point at which the price is too high, but if the business itself is one of those handful - maybe dozen or so enterprises in the world with exceptional economics that don't have much change in the core economics - as long as you're getting the Treasury bond yield or better, I think trying to get a cheap price is ultimately costly in the end."
Worded my thoughts better than I could - that's exactly what I've been debating in my head.
"Some action is better than no action" does not apply to investing. But if you've already done your homework on a specific company, found it something that you wish to add to your portfolio, it's probably best to just pull the trigger and make the buy, assuming the price is not outrageously high, instead of sitting on your hands for a year, waiting for the magic number to come along. If it's in the ballpark and is a fair shake - make it happen.
A Patel
December 24, 2013
Replying to Joshua Kennon
Joshua- Can you delve a little deeper into what you wrote above: "...but if the business itself is one of those handful-maybe dozen or so enterprises in the world with exceptional economics that don't have much change in the core economics.." I am curious what companies make your cut.
Emma
December 10, 2013
Hi Joshua, your unbridled enthusiasm for KO is contagious 🙂
I'm a newbie at this and you are obviously very knowledgeable about the subject but I do have some questions/concerns:
1) Do you think the stock can perform anywhere near it's historical performance given that it is already a huge and mature company?
2) Another concern: given widespread health awareness & the existence of the internet, even people in new markets overseas may not be as enamored by Coca Cola or sodas in general as Americans were way back when. In that case, growth may be mediocre at best.
What do you think?
Paarthurnax
December 11, 2013
Replying to Emma
While I'm not Joshua, I'll give some 2 cents until he replies.I wanted to make a point on your new markets thought,
Coca Cola is a completely world-wide company. I have a picture (that I think I got from Coca Cola's annual report, but may be wrong) from 2011, showing a world map and the percent distribution of the 26.7 Billion unit cases of Coca Cola for the year. It may surprise you - but North America (US & Canada) accounted for only 22% of their cases. 29% to Central and South America, 15% to Europe, 16% to Eurasia & Africa, and 18% to the Pacific/Asia area (China, Japan, Philippines, Australia, etc).
Remember though - that earnings are what it's all about. And Coca Cola does just that, very well. I would expect very enjoyable returns over the next 50 years. Remember - Coca Cola was already a 77 year old company, at the start of Joshua's 50 year example.
Nick Pape
December 11, 2013
Replying to Paarthurnax
To add on to this, Coca Cola focused on being the premiere non-alcoholic beverage company in the world; as long as there are underage drinkers, there are profits for Coke or Pepsi to be had. Plus their brands and distribution system are rock solid.
Frederick
December 11, 2013
Replying to Paarthurnax
Not only that, but Coke can raise prices anytime it needs to, thus raising earnings. They have their hand on the earnings lever.
Joshua Kennon
December 18, 2013
Replying to Emma
Welcome! I think you're wise to ask questions like that! Those are things that pose a danger to an equity stake in a business like Coca-Cola or Pepsi; perhaps, even some chocolate companies, as well.
The heart of your question is, "What drives investment returns?". All of those things are obviously factors, so I took a couple of days and tried to break down the relationship of how they all interplay to help you see the bigger picture of how an investor in any company - Coke being only one example - is going to do.
I published my response to you a few minutes ago. You can read it here. I hope it helps you start thinking about how to frame those types of inquiries; e.g., how are they going to influence growth in earnings per share; is the valuation I'm getting low enough it could offset it (look at tobacco companies - declining consumption was more than offset by huge profit margins and wise capital deployment), ad infinitum.
Emma
December 30, 2013
Replying to Joshua Kennon
Hey, thanks so much for taking the time to respond with an entire post. I read & re-read it. From a layman's perspective, it puzzles me why Coke which is a non-necessity (which by the way I love but only drink about once a month if that) has a better long-term outlook than, say Kellog's which produces goods that are more of a necessity or Nestle (which I know you think highly of). Of course the Coke brand is iconic & I do have it in my portfolio as a permanent position but somehow, I just don't have as high expectations as others. Maybe that's just as well.
Thanks, Joshua.
Rob
December 11, 2013
This article just made me pick up more shares of $KO, and buy a 1996 Coca-Cola bear snow globe off of ebay.....
Jordi
December 11, 2013
This topic (what's the maximum price
one should pay for a very high quality company like KO) is something I've
lately been thinking about too. Some time ago I read a very interesting article written in the late nineties by Jeremy Siegel. He analysed the returns over a period of 25 years of 50 high quality stocks (the Nifty Fifty) that became extremely overvalued around 1972 (which was the starting point of the period analysed). In the 80s people talked about the Nifty Fifty as an example of irrational valuation (Coca-Cola had a PE of 46 in 1972). However, Siegel found out that (despite the apparent high price) if you had bought KO shares in 1972 and held them until 1998 you would have had an annualized return of 16.2. Not bad at all...
The same applies to a lot of other high quality stocks from the Nifty Fifty group (like GE, Philip Morris, etc). Interestingly, the return shown by the technology stocks of the group was pretty bad.
During that 25 year period KO managed to increase its EPS at an astonishing annualized rate of 13.5. It does not look like it'll be able to repeat this in the next 25 years... but you never know. In any case, this article shows that we should be willing to pay much more for very high quality stocks than for regular stocks... And it's completely aligned with Joshua's recommendations of buying stocks like Nestle, GE, etc and forgetting about them for a long period of time.
http://www.aaii.com/journal/article/valuing-growth-stocks-revisiting-the-nifty-fifty
FratMan
December 30, 2013
If Buffett sold Berkshire's Coca-Cola stake in entirety, what do you think would be the reaction of the investor community?
FratMan
February 18, 2014
Hat tip: You may want to buy some Coca-Cola before the extended market hours close.
FratMan
April 11, 2014
If you were Buffett, how would you regard Coca-Cola's executive compensation plan?