Pepsi vs. Coca-Cola Investment Returns Over My Lifetime
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.
Reader Comments (51)
Comments are presented chronologically, with replies indented beneath the comments to which they respond.
Rob
March 2, 2015
Joshua - It's a pleasure reading your articles. Thank you for the insight you provide!
Angie
March 3, 2015
Can coca-cola never be brought down from no.1 position ? In theory, what would it take for a company to beat it ?
Iron Mike Sharpe
March 3, 2015
Replying to Angie
I think it would take the Chinese, playing a joke and putting pee-pee in the Coke to bring them down.
Joshua Kennon
March 3, 2015
Replying to Iron Mike Sharpe
If the Belgian Coke Crisis of 1999 with hydrogen sulfide contamination, hospitalized children, and a continent-wide panic (which are thought by many to be entirely a case of mass psychology gone awry) didn't do it, I don't think something like that would be sufficient.
Even if it did, you'd still have hundreds of other beverages in almost 200 countries pumping out cash for the parent company. A tea drinker in Saudi Arabia isn't going to associate the product, which has no physical connection to the incident, with a soda in China.
It would take something much stronger or severe mismanagement in the capitalization structure, like loading the balance sheet up with incredible amounts of short-term debt that suddenly couldn't be refinanced.
Super brands are powerful things in the human mind. Look at the Tylenol Murders of 1982. Once the crisis had passed, people went right back to buying Tylenol.
Joel
March 5, 2015
Replying to Joshua Kennon
A key factor in the Tylenol case was the corporate response: They immediately notified all customers (yes, even paying for ads telling people not to use their product) and recalled all potentially affected product. In the aftermath, they upgraded their tamper-detection devices.
The end result was actually greater consumer trust, such that the story has become a case study for corporate Public Relations.
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Muhammad
March 3, 2015
hey Joshua, its totally an awesome coincidence that you wrote this post at this time since i have been reading your 25 year investment case studies to my dad for the past couple of days and we have both been enjoying ourselves thinking about the kind of returns one can generate by investing in a few of the top corporations of the world without having to lift a finger (aside from keeping up with the SEC filings).
For my dad that is something totally new AND AWESOME as hes a guy whos worked hard all his life to make a living. He made a few real estate investments on which he earned decent capital gain but the assets did not generate ANY cash flow! talk about waste right! as you already know, Pakistan (my home country) has a very inefficent/ineffective law and order situation and people here usually invest in real estate and most never convert the property into rent generating assets because they are afraid of land grabbing mafia. its a real pain in the neck.
Thanks to you I was able to help him adopt a new way of thinking: which is to hold cash generating assets so that you dont have to work yourself your whole life. He's totally ecstatic at this few found way to financial freedom.
P.S: i know your busy and i dont mean to push u but when do you think will it be possible for you to come up with an answer to my mail bag question? (one regarding investment portfolio without debt based investments).
thanks!
Eric
March 3, 2015
Replying to Muhammad
Why would you want investments without debt? If your company makes a product with a 20% profit margin, and you can borrow money at 5% to make more of your products, you gain the spread of 15% on every additional item you sell. It's similar to the principle banks operate on. They take on deposits (debt) and invest it at higher rates of return.
Muhammad
March 3, 2015
Replying to Eric
Eric, your right. it makes perfect sense from a business stand point to borrow money especially in a situation where the expect return is greater than the cost of debt. But the thing is that i'm in the process of setting up portfolios for a couple of Investors who do not believe in investing in interest bearing securities. It's a religious constraint on their part. hope that helps. 🙂
Eric
March 3, 2015
Replying to Muhammad
Gotcha, understood
Connelly Barnes
March 3, 2015
Replying to Eric
Muhammad: I was curious about your question (although I am either agnostic or deist in belief, and know little of religion).
Because many modern corporations involve large amounts of debt, it would seem that halal investing would become difficult if one insists on very strict standards. After some Googling, I discovered that a halal investment advisory called Saturna Capital applies rules such as eliminating companies with:
" - Greater than five percent of their revenue coming from haram sources.
- Greater than 33 percent total debt as compared to their market capitalization (trailing 12 month average)
- Greater than 45 percent accounts receivable as compared to their total assets (trailing 12 month average)"
The main article:
http://www.saturna.com/amana/halal_investing.shtml
Joshua Kennon
March 21, 2015
Replying to Muhammad
Oh man! I am so sorry I let that fall off my radar, I remember working on it awhile back. Do you remember the last time we discussed it? It might help me find the file easier because I had started to write out my thoughts to get a response published for you.
Muhammad
March 22, 2015
Replying to Joshua Kennon
Hey Joshua! thank you for the response. can i get back to you on this in by day end today?
you see i'm giving my CFA level 2 exam this june and i have a test today, in a few hours, for the prep classes im taking. im busy studying for that at the moment. (Test is on Alternate investments in case you were wondering).
P.S: As i'm studying for the exam im also making notes and writing down questions so that i can post them here on your site to get your insights on the topics which i found to be interesting for one reason or the other. Cant wait to get over with the exam so i can get your insights! Cheers!
Joshua Kennon
March 22, 2015
Replying to Muhammad
Of course, and good luck on the practice exam!
Muhammad
March 23, 2015
Replying to Joshua Kennon
Hey Joshua! I looked up our previous conversations and I dont think we have discussed the topic earlier on the site, as yet. you did however mention that you were working on it (article on how to create a portfolio without any debt based assets) in a post in which you discussed the importance of using the financials of companies in order to understand the underlying businesses.Conversation was in the following article: https://www.joshuakennon.com/krip-gone-british/
sorry for not being able to come up with this yesterday. I was way to tired when i got back home from my class and went striaght of to sleep. 🙂
P.S: I aced the test which was on Alternative Investments btw. I find real estate to be an awesome asset class especially from the point of diversification. I mean it would be generating cash even when, in case, the stock market got shut off for a couple of years and we could not access any of our money. I just love that idea. I'm also lining up some great questions and observations while studying for the CFA exam. I will start posting them when im done with the whole thing in june.
Also I have been studying for two back to back tests for the last 3 weeks without a single day off. I'm in a mood to just kick back and relax for a day or two in order to treat myself for a job not all that badly done. 😉 ......so today im going to treat myself by going through your blog the WHOLE DAY!!! its going to be a fun day i can tell. 😀
Joshua Kennon
March 23, 2015
Replying to Muhammad
I solved the mystery! You sent me a message on October 11th, 2014 through the contact form. I was working on it but got sidetracked. I'm so glad you reminded me. I'll try to get to it in the next couple of weeks. (I've fallen so far behind on updates here on the blog because I've been busy with tax season (returns are due in the United States soon), plus I have to catch up on several business-related things for one of the companies.)
All of my free time has been going to Cities:Skylines, the new game that was released that is the best city simulation in 15+ years. Then, today, we picked up the new Final Fantasy game for Playstation 4 but I'm controlling my time there by trying to play only when I'm exercising so it's at least productive.
Congratulations on the test!
Muhammad
March 23, 2015
Replying to Joshua Kennon
thank you Joshua for wishing me on the test! hope you get through the tax season soon as im sure it must be a stressful time considering the amount of paper work one must go through to have everything in order......
As for gaming......Man I used live and breathe console gaming! it was such an awesome time.....staying up all night with friends and brining the smack down hard on those poor souls!(u see i was ok at attacking but was phenominal at blocking....you can imagine the pain that caused to the general public!) what a way to live! but sadly then CFA happened and WHAM! now all my free time is spent getting over the SMACK DOWN my studies have brought down on ME! my awesome blocking skills are not effective at all when it comes to the CFAI curriculum whopping my ass.... >:( :`(
BUT not to worry! I plan to fully treat myself once im done with the exam and i intend to buy myself the LATEST PS along with a few titles ive got on my list!!! one of my favourite titles is METAL GEAR. i just love the Japanese for making that game!
As for sim city...never played that one! was crazy about sims though......but after having read your posts on the game(sim city and now Cities:Skylines) i'm beggining to wonder just now why not give it a shot......i may like it considering that ill get to be the all powerful administrator and that kinda thing always appeales to me......
ive watched some of the final fantasy animated movies but never played that one either.....except for that one of SEGA genesis......mentioning that console makes me feel like a dinasour.....but some of the older titles were pretty damn cool......i used to love all the super mario titles .....
As for you playing while exercising.......man i gatta see that! i mean how do you even cycle while concentrating on the screen with the game controller in your hand......you must have one killer hand to eye and legs coordination!! btw do you begin to cycle faster as some boss begins to attack you and your energy levels get dangerously low??? just wonderin.....:)
P.S: it would be great to get that response on that mail bag question.....even if its in a few weeks.....ill put it on my things to look forward to thank you very much.
difff23
August 23, 2016
Replying to Muhammad
Did you ever get an answer? (article on how to create a portfolio without any debt based assets)
Care to share with the rest of this community? Thanks in advance
Muhammad
August 23, 2016
Replying to difff23
Hey Difff23! I'm afraid not. I believe Joshua has been pretty busy with the global wealth management business for a while. But I will definetly remind him again! and of course if and when I get a response, I will be happy to share with the rest of you guys, here.
difff23
August 23, 2016
Replying to Muhammad
You're awesome! Thank you for the prompt reply.
Scott McCarthy
March 3, 2015
Man, if I were a Coke drinker, and on my 21st birthday I found out that my twin brother had 6x as much in his account because he preferred Pepsi, I would have to reevaluate my soda preferences.
J.
March 3, 2015
Love these type of posts from you. I am a long time reader but this is my first post. Whenever I read these case studies it makes me wish I had found your site a little earlier in life. Keep on doing what you do, your way of teaching a complex subject such as stock investing is so simple and clear even a 2 year old could understand it. Extremely valuable stuff!
Brendan
March 3, 2015
Replying to J.
Same here. I've done a few "what if I bought xyz in 1984" and have always been impressed with the results.
Joshua Kennon
March 21, 2015
Replying to J.
Welcome (officially) to the site! Thanks for coming out of the shadows!
Brendan
March 3, 2015
These are fun to read. A case study I have been looking to do when I get a break from work is on GE, which I know you've written about, but my time horizon would be much shorter. In 2001, when I was a senior in high school, I had saved about 9k from my after school job and put that 9k in GE, as my grandfather urged me to as it was trading in the low 30's and he thought it would "pop". While I roughly knew what a stock was, I had next to no idea about splits, dividends, and the future potential cash flow of GE, which is why I sold it (again, at the urging of my grandfather) about a year later for a loss of several hundred dollars, in order to use those funds to pay for college. In my early 20's, when I started reading your beginner's investing blog on About.com and also read "The Only Investment Guide You'll Ever Need", I quickly realized my error...one not to be repeated.
Corey W
March 3, 2015
I figured this was as good a place to ask you this as anywhere, (I assume that you get so much mail in your actual inbox that you can't possibly see it all, and that this would have a better chance of getting answered here, apologies if that's not the case)
I'm just curious, as aside from panics such as the 2009 recession and such events, acquiring companies such as GE and Wells Fargo at ridiculous valuations(large or mega cap) seem to be a once in a lifetime maybe three times if god is on your side type of possibilities. Using the value investing approach, it seems the best possibilities to acquire undervalued securities would lie in the small to mid cap arena, but you never seem to discuss these on your website or personal blog. Why is that? Am I wrong?
I am by far a novice investor, and have been pouring through your about.com site and personal blog for about 9-12 months(I don't have any money to really spend on books(I'm 19 and struggling to even find a job, but I did get the Intelligent Investor and Security Analysis(1940 Edition)), and would like to thank you and offer my gratitude and sincerest respect for all the knowledge you have shared with me and I'm sure thousands of others. I just want to acquire the knowledge now, so when I have the capital I'll know what to do with it)
Guest
March 3, 2015
Love the case studies. They single-handedly changed how I view a long-term investments and the power of compounding.
Adam
March 3, 2015
Love the case studies. They single-handedly changed how I view a long-term investments and the power of compounding.
I would lean toward a single stock gift, just to avoid potential strife.
Muhammad
March 4, 2015
Yes, since most investments have some sort of debt arrangements, some Islamic scholars have come up with solutions to help the Muslim community in making it a little less difficult to invest then it already is, for most people.
One thing, regarding investments in debt free companies, that helps me sleep better at night is the fact that Warren Buffett has said on many occasions that a good company is one that can fund its own growth without needing to borrow (or growing through retained earning).
I heard Buffett say in one interview (regarding debt) that "if your smart, you dont need it and if your stupid then you got no business getting involved in it"
If we look at the Return On equity Dupont Model (which is Net Profit Margin * Asset Turnover * Leverage Ratio) we can see that companies that are increasing return on equity using the first two components (that is net profit margin and Asset turn over) are actually preferred investments rather than a company that is increasing profitability by simply increasing debt in the capital structure.
Brendan
March 4, 2015
Hi Corey,
After reading your comment, here's some advice that could help. Take it or leave it.
I'd suggest starting with an index fund that can be bought with a small amount of initial cash, and can be contributed to regularly without incurring commissions for the time being (or whenever you start your first job). As Warren Buffet often says, he can't predict what the market will do, but there are intelligent things to do in the meantime. I agree that value is important, but at 19, trying to wait for another crisis like 2007 or valuations in early 2009 is irrelevant for you because your time horizon is quite long, even if you wanted to retire at 40 (not that you do, but just to make a point). You could even invest in a fund like VISVX, a small cap value index fund. Another point is that there are recent times when mega caps are undervalued, such as Exxon and Mcdonald's late last year and early this year, or Nestle, or Diageo, and while they're not wildly undervalued, it's still a great time to buy because you can be sure that you're not currently overpaying for future earnings...and that's the most important part. Also keep in mind that even if you lump sum invested at the height of 2007 in an S&P index, you'd have made your money back and then some within a little over 2 years (results were even better with small cap index funds).
So, in a nutshell, keep learning, invest in yourself so that you can get a good job that you enjoy and start putting money aside as soon as you can.
Corey W
March 4, 2015
Replying to Brendan
Hey Brendan! Thanks for replying!
That sounds like a good idea
actually. I really enjoy the intellectual stimulation of going over
annual reports and financial statements, and I suppose I get so caught
up in valuation and individual stock selection that I forget index funds
exist, A mistake on my part probably due to my over-enthusiasm and
youth. Further self evaluation in my investing and life philosophies
seems necessary in that case..
Thank you for replying! If you or
ANYONE( that's rational and following the value investing approach (as
I've seen few, not many, but a few, irrational and foolish comments on
investing on this site before, often followed by a sharp reply from
Joshua exposing the fallacies in their thinking) has any advice on
investment, stocks, or anything really I'd appreciate it more than you
would imagine! (I wish more people my age were into this stuff, but what
can you do?As such I generally don't have anyone to talk about this
stuff with or to gain insight from. ) Sorry for such a long reply, I'm
getting caught in my own enthusiasm again to be actually discussing this
with someone.
Brendan
March 4, 2015
Replying to Corey W
Finance is something you either love or hate. I was interested in it at a young age, most of my friends, my wife, and my younger siblings would rather go to the dentist than read a finance blog, let alone an annual report. But for those of us who do find it terribly interesting, there are hours of You Tube videos with Buffett, Bogle, Munger, and Gates etcetera, giving interviews and talks.
Check out Charlie Munger's lecture on Cialdini and investing psychology if you haven't already and also read Cialdini's short book, "Influence, the Psychology of Persuasion" if you feel inclined. A pdf of the book is free online. Some other blogs I read with great discussion communities are Mr. Money Mustache and Bogleheads, along with Joshua's blog.
Muhammad
March 5, 2015
Replying to Corey W
Hey Corey, reading your posts here made me go down memory lane myself. That is just 7 years back I was MEGA interested in making money but didnt know anything about investing, compounding or any of the other good stuff. But that was all before i found Joshua's website!
I would read his blog and the about.com webstie religiously and in just a short period of time (6 to 7 months) was all set to take on the world with a new found conviction.
to make a long story short after having read Joshua's writing i quit my job as an information technology technician which i didnt really hate but was also not in love with and decided to pursue a career in investment management. Just like you I'm pretty nuts about finance and investments and just love learning all the cool stuff and then applying it in the real world of money and finance.
What i would like to share with you is something very simple. If you are interested in stocks and investing (which i can tell you are!) you should remember two things 1) investing is about identifying good businesses in which you can invest in and 2) learn to value companies so that you know how much to pay for it so that you earn a good return and dont really overpay for anything. As you may already know that if you overpay for even the best businesses in the world you will end up getting a poor return on your investment.
I think you will need to spend time learning both of these things. I personally spent approx 2 and a half years just learning how to value companies.....yes you may go ahead and laugh now.....i will wait till your finished,..... 😉
once i learned how to value companies (that is the science behind the scenes) i then started learning how to identify good companies. again Joshua's blog was very helpful. I especially recommend reading his post on what makes a good business vs. a bad business in which he discusses a cruise liner business (very asset intensive requiring heavy fixed capital expenditures) and a spice manufacturer (very low on fixed capital requirements).
If you can get to understand these two parts together, you should be able to make your own investment decisions which i believe will pay of tremendously in the future, I know it will take a substantial amount of time but its all worth it in the end.
James Eastman
December 11, 2016
Replying to Muhammad
Sounds like sound advice-as a beginner investor, I am in much the same boat myself. Are there any books, etc you would recommend dealing with the subject of company valuation/evaluation? Thanks for your help
Muhammad
December 12, 2016
Replying to James Eastman
Hello James! of-course! it would be my pleasure. But first, words cant tell what an amazing journey you are about to embark on. Studying finance is as fascinating to me as life must have been for the Star Trek crew.....flying through the stars, coming across so many things they had never imagined or thought possible. Its down right awesome!
Since I get to talk to a lot of moneyed people, who are not initiated in Finance, I have come to realise that many of these people think they will need to work hard throughout their lives to grow/maintain their wealth. Initially I held the same belief but thanks to my new found understanding and skill set (financial/business analysis), I now know better.
I know one high net worth individual who invested in real estate but there was no cash flow from the properties because where he lives and invests, there is powerful land grabbing mafia and renting out property is frankly asking for trouble. When I asked him why he didn't invest in stocks instead (especially given the fact that when he invested in these properties he was quite young and stocks would have been a great place to put surplus capital), he said stocks are speculative investments and that he did not want to gamble with his capital.
No doubt his investments in real estate have generated massive capital gains over the past 40 years, however, he completely missed out on cash flow, which is a very important part of total return (Total return on investment = capital gain + cash flow).
I thought to myself if this gentleman had invested in a safe, stable blue chip example Nestle S.A, which has steadily increased it;s dividends over the years, his total return would have pretty much clouded the investments returns generated by his real estate investment which did not have any cash flow component at all.
My point is that if he had understood finance, like you are doing now at a relatively young age, his financial situation would have been a whole lot different, with much less effort (real estate even if rented out is a management intensive business unless one has good management company looking after the properties while stocks pretty much require no personal involvement in the day to day running of the business. All one needs to do is keep track of the companies performance over time which can be done pretty much sitting on a sofa with a computer, an internet connection and a cell phone.) Spending time learning finance pays off like crazy!!
Sorry about the long rant but I just cant help feel happy when I see someone about to go on the same journey as me a few years back. Now, lets get down to your question: are there any books I would recommend to learn business analysis and valuation?
The first book that comes to my mind is the CFAI (Chartered Financial Analyst Institute, USA ) Level 2 curriculum book on Equity investments. This is the Bible of equity valuation! Get it and it should give you a pretty strong grounding in valuation. If you are interested in bonds and other asset classes such as real estate and derivatives etc, then I suggest you get the entire curriculum for CFA level 2.
Frankly if you are new to finance then I suggest you also spend time on understanding financial reporting analysis, corporate finance and economics. the best place to start is the CFA level 1 curriculum books on all three subjects.
Note: once you get the hang of individual asset classes like stocks, bonds and real estate then I highly recommend you spending some time studying portfolio management. Again the CFA curriculum (both Levels 1 and 2) should serve you well in developing a solid framework.
If you have any other questions then please feel free to hit me up over here. Ill be glad to answer any further questions you might have.
Cheers! 🙂
innerscorecard
March 6, 2015
Replying to Corey W
You're also forgetting that you don't need phenomenal returns (buying companies at Great Recession prices) to do well. You don't have to shoot the lights out to have good results for yourself.
Don't let chasing the great be the enemy of the good.
Corey W
March 6, 2015
Replying to innerscorecard
"Don't let chasing the great be the enemy of the good." Having never heard that quote before, thank you as it was marvelous and had I heard it a long time ago my entire life would be much different. I tend to get caught up in searching for the highest value at the lowest price that I forget acquiring a good company at a fair price can also yield a satisfactory return. I'm always hunting for bargains in other areas and that has transcended into the realm of my personal finances.
@Brendan (not sure if that function works and tags you specifically, I'm unfamiliar with the disqus system so I apologize, I don't read a lot of internet blogs, I tried reddit once and found it to be a good case study for how not to view investing or personal finance, as such I tend to stay away from forums and the like, the irrationality is just startling. But I will check out the sites you recommended, and I thank you and appreciate them) I listened to the Charlie Munger lecture today,
as well as a lecture from Buffet at the University Of Florida. I would MUCH rather get my hands on a copy of the book in physical form( I just prefer to read them that way,) but I will check out the PDF version because of my limited resources. and honestly, you can't beat free!
Thank you for the recommendations. And @innerscorecard:disqus , I figured the same after I wrote it, I guess I was more so hoping for a a reply from him as the conversation of it would be more interesting to see his more aggressive investments, as he is one of my most revered and respected teachers on the subject, it would be like sitting in an old classroom at Columbia and having Ben Graham in front of you laying it all out for you, just a beautiful process to be privy to. Thank you for all your
comments, suggestions and replies.
@Muhammad I wouldn't laugh, we all have our own mental processes and the longer it takes the longer it retains! Yes I have read that post, it's interesting to me, as much as investing and the finance markets are represented in
mainstream media as being for ....pardon me.......but for super genius college graduates that live in penthouses or mansions sniffing cocaine and shorting regular investors using accounting gimmicks to make themselves rich (a popular archetype in U.S at least, it would seem) it isn't like that all. Investing seems to be based more on psychology, rather than numbers, and if you have an ability to do basic arithmetic, and an understanding of business and accounting terms, looking over
financial statements isn't truly to difficult, I'd even venture to say
the average high school student can do it. It seems the biggest enemy in long term investing is the inner psychology of most investors obsession with capital gains and getting rich quick, combined with an over-enthusiasm to always be actively trading. A sense of rationality will take you far and put you lifetimes ahead of the average person investing when the market is high and selling when it is low. At least, that is what I have taken away from my studies. It isn't the analyzing, it's the psychology. But I'm still a novice, so I may be off in my conclusion(which I haven't even truly reached yet, as I'm still adding information to my foundation of investment philosophy, and expect to continue to do so over my lifetime as a man never stops learning.) Thank you all!
Joe Dias
March 4, 2015
"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...."
I am unfortunately finding this to be the case with a close family member who knows nothing about asset valuation, business, investment, or anything of the sort. This family
member wants to drop over half of their net worth into an annuity, but with rates so low right now there could not be a worse time to purchase an annuity. This family member is a classic example of you can’t teach an old dog new tricks. So, she mentally shortcuts to fear for anything she does not understand. In her mind, “the stock market is sure to crash very soon and the world is going to be in some sort of chaos.” It’s frustrating that they don’t see their own mental biases and end up making bad financial decisions. It is frustrating to me as well because I do think with rates as low as they are and her extreme risk aversion, that an annuity is probably the best answer for her. Even putting the current 30 year treasury return (something I've read on your site that is not a good choice to invest in currently) in MS Excel and applying a 4% withdraw rate does not get her to the average life expectancy without running out of money. So I guess an annuity is the answer for now, though when you apply inflation to the purchasing power of an annuity, in ten to twenty years the purchasing power is devastatingly inadequate.
Even I am uncomfortable with my ability to value stocks, so I stick to large cap mutual funds. To get to the point where I could invest without a feeling that I was doing so based on faith alone I had to read a lot of investment books and web content, many of those books being ones that recommend. The one for me that comes mind is “Stocks for the Long Run.” That book, along with your site got me to the point where I felt investing in mutual funds was fact based rather than faith based. Most people never get to that point though as it takes a considerable amount of research to come to that fact, not faith, base conclusion.
David Wang
March 5, 2015
Is it possible if we compared this to Dr Pepper's performance?
Joshua Kennon
March 5, 2015
Replying to David Wang
Unfortunately, no. Dr. Pepper was publicly traded for a long time and, in fact, like Coca-Cola, was one of the single best performing buy-and-hold investments of the 20th century before it was taken private. It changed corporate hands several times before being sent off on its own, through an IPO a few years back, and is now re-emerged as a stand-alone business for the first time in decades.
The economics are comparable, though. I think someone can make a strong, convincing argument that it is one of those rare companies you want to own for the rest of your life. In fact, I once wrote about just going the quasi-index route and buying all three firms as a basket, which will probably lead to more than satisfactory results if 1.) we are looking at a 25+ year period, 2.) the owner dollar costs averages into them so overpriced bull markets are made up for by underpriced bear markets (things get crazy in either direction from time to time), 3.) costs are kept to a bare minimum, including, possibly, holding them in a tax shelter such as an IRA, and, perhaps, 4.) reinvesting dividends.
Chris Hope
March 8, 2015
Replying to Joshua Kennon
Joshua, What would you do if Pepsi spins off it's snack food business? Would you continue to own the original beverage co. or sell it off?
David Wang
March 10, 2015
Replying to Chris Hope
Do you think there is a possibility of Pepsi spining off its snack food business?
Joshua Kennon
March 11, 2015
Replying to Chris Hope
That beverage business is what paid for the restaurant business and, later, snack business. It was the primary economic engine that, despite the decline of carbonated beverages in the United States, still earns very good returns on capital for something of such large scale. I'm perfectly willing to buy Dr. Pepper Snapple and / or Coca-Cola, so why wouldn't I be happy owning a stand-alone Pepsi? Even if all it did was buy back stock and up the dividend every year, it's largely free surplus cash. That's appealing to me, even if Wall Street hates slow growth businesses. I'd be happy with it having a spot in my collection of things sending me checks and direct deposits. I wouldn't see it as a problem at all. I have higher growth positions elsewhere in my life so planting a few oak trees for old age isn't something I consider a tragedy.
I mean, it's not like it's a shipbuilder or something. Have you seen the returns of that industry over the past century or two, especially in places like England? They're just terrible, terrible businesses despite their importance for civilization.
(Keep in mind, I'm talking about the business itself in terms of attractiveness, not the stock at any given moment. I have no interest in a stand-alone soda business at 70x earnings with huge global market share, obviously, as that's not the conversation we're having.)
innerscorecard
March 6, 2015
I don't want to put words in his mouth, but I'd venture that Joshua doesn't write about small stocks or more enterprising situations because that could actually move the market. Notice that what he writes about is what he does with retirement accounts or family accounts. It's the Defensive Investor side of things. Based on his returns, I sincerely doubt he wouldn't do anything in the realm of the Enterprising Investor.
CharlesMakesCents
March 8, 2015
Hey, Joshua,
I really love articles like this. I just found your blog (unfortunately--wish it had been sooner!) on Steve @ Kapitalust's recommendation.
Also, while I hold PEP and like many of your brands, you're definitely right about Coca-Cola being the better cola. I love that Mountain Dew, though.
Joshua Kennon
March 22, 2015
Replying to CharlesMakesCents
Welcome to the site!
Joshua Kennon
March 22, 2015
Back in 2000/2001, one of the mentors in my life, the woman who ran the major music conservatory in Kansas City and who had done well, had made a lot of money from her ownership of General Electric. She would cackle from the Steinway piano (she knew about my finance obsession), "Just buy GE! It always goes up!" then launch into song. And, for her, it certainly had for year after year, I think maybe even decade after decade.
I pulled the annual report as a junior and senior in high school and it had become completely and totally deranged. It was 30x, 40x+ earnings. For one of the biggest companies in the world. Crazy. Mathematically, it couldn't possibly justify the price at which it was trading, or anywhere near it. I kept reminding myself of the advice of the older, successful value investors when they said (consolidating and paraphrasing here), "Do not sacrifice your values for temporary satisfaction. If the market has truly become irrational by normal metrics of value, there will come a point at which you will get your price." I just had to trust they knew what they were talking about so I went on to other things, always watching. I had so much respect for this woman - she changed the direction of my life and ultimately led me to going to the university I did - but I couldn't go against my own judgement when it came to money. If I couldn't make an argument for it based solely on the relationship to future earnings, I wouldn't part with cash.
I waited. Year after year, the situation didn't improve. There were always more attractive things. Nearly a decade went by and then - boom - in one, nearly instant, crazy series of events, it collapsed in the Great Recession, losing at least 80%+ of its peak-to-trough quoted market value. I bought it everywhere. I had my parents buy it. I had my brother buy it. I even had a long-term employee of my dad's business, one of the few people I'd help since I had known her so long, buy it. I had my Great Aunt buy it. It was just so, so stupidly cheap and people were running from it like crazy. The stigma remains. For a 10+ year owner, the price today makes it among the most attractive 3 or 4 businesses in the Dow Jones Industrial Average in my estimation. Within 36-60 months, you're probably looking at a 5.5% to 6.0% cash dividend yield on cost, barring any major surprise. It's one of our top five holdings.
The price back in 2000/2001 though ... it was so horrifically bad that you should count yourself lucky you didn't hold it relative to your other opportunities. You could have parked the money in Treasury bonds and earned, what, 2x or 3x the earnings yield equivalent? Read this for more information.
The thing I find somewhat heartbreaking and somewhat hilarious, is coming across someone who will complain about the last 14/15 years as being "lost" for GE. You've held all this time and your purchasing power has declined. They never want to own it again at any price. Yet, here we are, the situation completely reversed. The base company, with no growth, is offering many, many times the Treasury bond yield. The price you are paying for an equity stake today is among the best deals for large blue chip stocks you can find. Nobody wants it. They won't go anywhere near it. (I like it so much these days, I had my niece buy a tiny amount of it for her custodianship.)
Anyone who thinks the markets are perfectly efficient is a fool.
You have to make sure the starting price is at a minimum reasonable relative to future earnings. If it's not, it can take years, or even decades, to burn off that overvaluation. No one had a right to expect a position return from GE at the price that prevailed a decade-and-a-half ago. Today, it's a different story.
Personally, I'd be so happy if it went sideways for ten years but the earnings and dividend yields kept getting higher so it could just compound itself like nuts. It probably won't happen but a guy can dream, can't he?
(Note: This is not a stock recommendation. I'm just letting you know how I approach these things. GE could ... I don't know ... unleash the zombie apocalypse tomorrow and go to $0 per share. All I can do is estimate what I think are reasonable probabilities where I'm getting a higher chance for a great return than I'm paying relative to my other options and this is one of those cases if you aren't interested in the next 1, or even 3 years, but rather the long-term.)
Joshua Kennon
March 22, 2015
You're aren't wrong. I've brought it up from time to time in the past. Prior to the Great Recession, almost everything I owned in my life had been a micro, small, or mid-cap business because there was just more value there. A few exceptions existed but I started making money at a time when the blue chip giants were overvalued to the point of once-in-100-year pricing. When I got my chance to get my hands on some of the best businesses in the history of the world for next to nothing, I took it. The result? Our portfolio consists disproportionately of mega capitalization businesses. That wasn't even remotely the case prior to 2009.
Lately, as dividends get deposited and other cash piles up, I find myself slowly wandering down the size chain, again. It will take a long time to re-weight the portfolio to smaller stocks because some of them have appreciated so much but I'm purely opportunistic. I go where I find value.
In almost all cases, I won't discuss those non-mega cap positions, though. Part of it is for competitive reasons and part of it is self-defense. For example, a few years ago, I came very close to buying the shares of a barely-listed subsidiary business of another public company that was so illiquid, the stock broker placing the trade made me sign a digital waiver explaining it could take months to sell the stake if I ever tried to dump it. That is not even remotely appropriate for most people. It's a different game entirely and I'm not going down that road. I ended up buying other things, but would have been perfectly fine had they been able to execute the trade and add it to my holdings.
So, no, you definitely aren't wrong. Practically all of my time in early life was spent in the then-S&P 500 Small Cap and S&P 500 Mid-Cap tear sheet books (which still sit on a shelf in my home and I periodically flip through just to see how much the world has changed). I'm here now, in mega-cap land, largely by an accident of fate; a gift from the heavens that let me buy things like one of the world's greatest banks for next-to-nothing.
dave (nestle)
March 22, 2015
Replying to Joshua Kennon
Joshua,
In a similar vein, would you mind going over your thought process about how you came to be interested in, excited about, and confident enough to buy Autozone shares, way back when? Just as an example. Was it the balance sheet alone that attracted you or was there some deeper understanding of the profit mechanism of the business? Please tell the story of how that particular stock came to be in your portfolio back when it was a much smaller company so I may see how you approached the purchase of a non-blue chip stock. What I find particularly interesting is why the auto business (was it a macro call?) and why not another play on the business. I don't know exactly what year you started buying it.
I am at a bit of a crossroads as far as my competency level versus available opportunities at the moment. I have been looking over smaller companies one by one lately. I have cash piling up for different opportunities but am slowly formulating ideas for some small cap stock investments. I tend to be attracted to the balance sheets and the profit growth over the last several years combined with the idea behind the businesses themselves. This is a very difficult thing to gauge for me. Your thought process would be invaluable on the subject.
Oh, I know there is little to no chance but... you wrote a post about a similar investment to autozone back in 2011. How did that turn out? What was the stock?
Thank you ever so much for all the help you give everyone here!!!!!!!!!
coldtusker
June 16, 2015
Great stuff! Keep it up.
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