The Concern About Coca-Cola Stock? Classic Short-Termitis

Over the past ten years, Coca-Cola has increased its profits from $5.0 billion to $9.2 billion. The profits per share have increased by a little more than that (from $1.03 to $2.10) due to a stock repurchase program that has reduced the number of ownership units you have to share the profits with from 4.8 billion to 4.3 billion. The company has increased its cash on hand over the past two years from $13 billion to $18 billion. The soda giant’s sales have gone up from $21 billion to over $46 billion during the 2004-2014 stretch. And plus, you collected a rising cash payment during each of those years we’re examining (and it’s a streak that now goes back more than half-a-century in total).

And yet, the price of Coca-Cola stock has declined over 5% this week. Why? Because the company missed analyst expectations by $140 million. That’s right—they brought in a little under $12 billion when the Wall Street consensus expected a little over $12 billion. It’s nuts; we seem to have entered this bizarro world where investors are intolerant of the fact that we have economic business cycles, and companies don’t grow revenues and earnings per share at a 10% rate annually into perpetuity. Profits went down from 1998 to 1999, only went up by $0.03 from 2001 to 2002, only went up $0.05 the year after that, and $0.06 the year after that. The company’s revenues barely went up from 2004 to 2005, but yet, experienced significant growth from 2007 to 2008 (earnings per share increased from $1.29 to $1.51, and revenues grew from $28 billion to just a tad under $32 billion).

It’s the nature of business. There’s a sportiness to the earnings reports of even the highest caliber companies, and you would be wise to take advantage of the temporary ebbs in the business cycle to add to your position, rather than waiting for the company to fire on all cylinders: When do you think you’ll be able to get a good deal on Coca-Cola stock—when the company reports sales that are stagnating, or when the company reports profit growth of 12%?

Someone who bought shares of Coca-Cola on October 21st, 2004 would have compounded his funds at a rate of 10.62% annually until October 21st, 2014, increasing your wealth by a rate of 2.74 if you held the stock in tax-shielded form like an IRA. Every $10,000 would have grown to $27,400. And this is a ten-year period that included all the things mentioned below—years that included modestly growing revenues and barely increasing profits per share. Heck, even this year, Coca-Cola is on pace to grow its profits from $2.08 to $2.10, and the per share dividend collected increased from $1.12 to $1.22.

This is what’s supposed to make investing fun—even in the bad years, Coca-Cola’s profits generally hold up (increasing modestly or declining modestly) and the payout ratio is flexible enough that you can still receive dividends that are growing faster than the inflation rate even during the rough years of the business. The current business difficulties, if you can call it that, facing Coca-Cola are perfectly characteristic with what Coca-Cola has done in the past ten years and still managed to deliver total returns just north of 10% annually (as an FYI, the current yield on Coca-Cola is 3.0%. The years 2008 and 2009 are the only times in the past generation when Coca-Cola had an average initial yield of over 3.0% over the course of the year. There aren’t a whole lot of high certainty places in the world where you can get 3% initial income attached to a very high probability of 8% annual dividend growth or better over the long term).

It’s a shame the financial literature out there right now misjudges the opportunity that exists in IBM and, to a lesser extent, Coca-Cola right now. If you’ve googled Warren Buffett’s name at all this week, almost all the headlines are about how he has supposedly lost $2-$3 billion in Coca-Cola and IBM this week, and a small minority of them even go as far as to suggest that he’s losing his edge as an investor. It would be humorous if not for the fact that honest, hard-working people actually make financial decisions in response to that kind of stuff.

Coca-Cola has a ten-year earnings per share growth rate of 8.5%. IBM has a ten-year earnings per share growth rate of 13.0%. The current criticisms of IBM and Coca-Cola discuss conditions that both companies have faced throughout the past decade, and still managed to deliver good returns to shareholders.

This is why I have a love-hate relationship with advances in financial information technology. On one hand, it’s great that someone just starting out can open an account with Loyal3, and start buying Berkshire Hathaway stock with $10 purchase minimums for a cost of $0. It’s a sign of progress for American society that the path to wealth-building so clearly exists if you acquire the knowledge and set aside a little capital to invest. On the other hand, we have a 24/7 news cycle that reacts to every quarterly report, such that it’s rare you find anyone around anymore who can say stuff like, “Yeah, I’ve owned these shares of Emerson Electric for the past 25 years.” When you have information blasted your way all the time, and some of it is negative, it’s extraordinarily easy to dispose of an excellent lifelong holding because you made the mistake of projecting short-term bad news far into the future when really all you’re looking at is the typical ebb and flow of the business cycle.

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10 thoughts on “The Concern About Coca-Cola Stock? Classic Short-Termitis

  1. ddh81 says:

    Tim,

    I feel compelled to disagree a bit with you on this one statement in the post:

    “It’s a shame the financial literature out there right now misjudges the opportunity that exists in IBM and, to a lesser extent, Coca-Cola right now.”

    No shame at all! This is exactly why Charlie Munger said that it’s not supposed to be easy. In fact, if there really is an oversold opportunity created by the reaction to print/online/television commentary, then you (and others as well) are simply supposed to say, “Wonderful. Let me buy that stock cheaper.”

    Personally, I’m not sure it is. I questioned a friend of mine after the close yesterday as to when was the last time the S&P was up almost 2% in one day while IBM, KO and MCD all declined on that same day? I only own IBM of those 3, and frankly it’s not the most comfortable position in my portfolio. I agree all 3 companies are still making a lot of money, are not trading at nosebleed valuations and looking at what’s happened over the past 10 years helps. However, I wrestle with long term trends in each of their businesses. That’s what makes investing so interesting and difficult.  

    P.S. If you really want to see something shameful, I might suggest digging up some Wall Street “research” from the tech boom of the late 90’s. Now THAT was pathetic!

  2. scchan_2009 says:

    Welcome to the crazy modern world of short-termism and algorithm trading:
    1) Hedge funds with computers analyse new releases and immediately short stocks with bad news.
    2) Fund and pension fund managers who care more about their own jobs and their clients start dumping stocks that under perform and go after the next hottest thing in planet with no regard of common sense.
    3) Fast information flow over the Internet (haha SA) means Joe the Investor or Jane the Investor goes on panic mode if share price starts to fall. (PS@ The word “investor” was misspelling of “speculator”).

  3. scchan_2009 says:

    ddh81 One inherit problem with investing is that (as Warren himself put) “The back window is clear and the front is cloudy.” Nobody really for sure with 100% confidence how KO or IBM be in 10 years; even I will say it is more likely to be around and doing reasonably well, this is just an estimate, and it does take some degree of faith to it (and I am putting my money into this “religion”).
    However, panic and short-term emotions are not going to make things any better. As Warren himself also put, it is temperament that makes a good investor. Yes the stuff for dot com is quite crazy. I remember reading Paul Krugman talking about that a lot in many NYT articles at that time. An interesting article here (not by Krugman but explained what on earth many fund manager may be thinking):

  4. scchan_2009 says:

    ddh81 scchan_2009 Anyway, I don’t think the situation is that hopeless, but I think something can be done about this:
    1) IRS can lengthen the term for the definition of “short-term capital gains” (12 months right now) or through the imposition of Robin Hood Tax to discourage high turnover from fund managers (now the fund investors would complain why the expenses would suddenly go up!).

    2) Ban public retirement money to go into unorthodox investment strategies or investment products (e.g. no derivatives, no hedge funds etc; their returns are terrible anyway; basically stocks, bonds, index funds only)
    3) Change mandatory quarterly reporting to annual reporting only

    4) Reduce the use of stock options for executive pay; all equity-based pay must have clawbacks attached with deposition at least 5-10 years from the day of award.

  5. scchan_2009 says:

    ddh81 scchan_2009 That Biggs quote is pretty good. It explains two things in one arrow – why market timing does not work, and hidden costs in mutual funds. When everyone are dumping these “rubbish (dotcom) stocks”, supply would overwhelm demand, and the price would nosedive; you have already lost money even if you think you have timed the market, and loses incurred at these we-are-dump-rubbish-together moments are not part of the reported expenses in the funds. The loses and costs are transferred to the investors, and fund managers are still flying First Class on United and Delta.

  6. says:

    Thank you for this! I rail against most of the organised Financial Industrial Complex, including the media that supports and touts it, so I am not surprised by what comes out on a daily basis. I would offer one comment though: you say “investors are intolerant of the fact that we have economic business cycles” … “They” are not investors, I am an investor. “They” are traders and as recent studies have found, only 1% or so successfully beat the averages, and it is not the same 1%, year over year. The rest of us, contrary to other studies that claim we are to stoopid to go w/o the aid of the under performing advisor, are doing just fine holding KO and MCD and MO, all the while picking up +3% dividends in our stupidity. (Hmmm, I wonder if I speak at all, if not ranting 🙂 )

  7. Someone001 says:

    Agreed.  Business cycles are a normal part of business and the economy, despite the attempts of the Feds to smooth it out.  

    Quick question, newbie here to dividend investing.  Coca-Cola seems to have a lot of different stock ticker symbols — how do you determine which one to buy?  Do they all have dividends, or just some of them?

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