Recently, people are starting to re-awaken to the fact that Coca-Cola is a business that earns 28.2% net profit margins, controls 3.5% of the entire world’s liquid supply, has the most vast distribution network of any manufacturer in the entire world, and has probably the most valuable intellectual property ever invented on its Coca-Cola assortment of brands that have truly global recognition.
The stock, which had traded in the $40s per share more or less since 2012, is starting to show that smaller packaging with higher unit costs and a ruthless focus on automation (that is largely underreported in the financial media) is driving a return to 7-9% earnings per share growth. With a dividend yield still north of 3%, it is now positioned for 10% to 12% returns over a multi-decade period.
That is especially true if you reinvest.
Maybe it all feels the same to investors who look and see the stock perpetually in the $40s, but it should be noted that the transition from $40 to $50, where the stock traded as recently as last week, represents a 20% gain. That’s quiet, but it’s about two years of historical compounding that accrued to shareholders who held on from May 2018 through November 2018.
I think lay investors get turned off by a stock when it spends several years without price appreciation. What is neglected is how much excess wealth gets created when reinvested dividends get plowed back into shares at a lower rate.
You might feel better if you buy a stock at $40, see it immediately rise to $50, then see it stay there for five years compared to a scenario where you buy a stock at $40, see it stay there for five years, and rise to $50 per share, but that is a misplaced emotion that will cost you money.
Why? Because if the stock immediately goes to $50, having given you your 20% gain, your reinvested dividends are bought at face value. But when the stock is stock at $40 for a while, each of those reinvested dividends has purchased initial shares which, in turn, receive their own 20% gain at the end of your measuring period.
Take someone who owns 100 shares of Coca-Cola and collects 4 dividends totaling $1.56 per share that gets reinvested at an additional price of $40 per share. This investor picks up just shy of 4 shares. Well, when the stock goes up to $50, it’s not just those 100 shares traveling to $50 to take your $4,000 in initial capital to $5,000, but you also get those 4 shares that cost you $156 increasing in value to $200. In a single year, $44 gets created in excess wealth from reinvested dividends just because of the price sequence.
Multiply this by five years, and Coca-Cola investors have received returns that are better than you might think. My above scenario even understates the case, as I didn’t rebase the share count upward, i.e. I took the initial 100 shares and acted like they received four co-equal payouts, when in reality, the reinvestor would have 101 shares after the first dividend, and that extra would then be forever generating its own dividends that would need to be accounted for.
It just creates this bizarre mismatch between the investor’s reality and what someone looking at a stock chart would perceive. You might look at Coca-Cola in December 2013, see it at $40 per share, and look at December 2018, and see it at $49, and think nothing much happened in the past five years. The stock calculators only suggest you’ve received 4.7% annual returns, but those algorithms treat dividend payouts like flat cash that is distributed and set aside rather than reinvested. It gives you the equivalent of what would happen if you collected all your dividends in a savings account yielding 0.0% and then kept the original shares, and does not account for those who take their dividends and use them to acquire additional shares.
For those that actually reinvested from December 2013 through December 2018, the actual results have been 6.2% annualized because you kept gobbling up additional shares that spit out their own higher dividends which in turn could acquire more shares. It is why the dividend investor, who only occasionally monitors his account, will find a higher balance than you’d expect. A lot of shares got bought around $40, and those additional reinvested shares are at $49, and that is a hidden 18.5% gain within a subset of shares that have been acquired that tends to get neglected.
It has become this old fogey, but all it takes is Coca-Cola rising to $63 per share with the S&P 500 staying stagnant for Coca-Cola to have outperformed the market from the December 2013 period onward. The lesson? He who owns a great business, and perpetually and doggedly increases his interest in that great business, during an extended period of stagnant prices, encounters a dramatically improved outcome when that capital appreciation does arrive.
If I had to bet on it, I would say a day will come when the investor of December 2013 in Coca-Cola stock goes on to outperform the S&P 500 with those very reinvested shares, and this period of $40s stagnation with reinvested dividends will be viewed as one of the low-key causal reasons why, for the same reason that Johnson & Johnson stock investors in the $60s during the 2000s now have excess returns with the stock at $145.
For those who got bored with Coca-Cola stock and sold, they received hardly anything for their 2013 through May 2018 patience, while the investor who invested during the narrow May 2018 through November 2018 period reaped most of the rewards. No one could have told you that this semi-annual stretch in the year 2018 would be responsible for much of the ensuing wealth, but that is why the “hold” part of buy and hold is stressed because he who never sells is guaranteed to capture these gains.
The May 2018-November 2018 investor gets the dinner, but the December 2013 through May 2018 investor paid the tab. Holding for the long haul ensures you’ll never be the investor who is the latter.
Of course, this also provides protection during market declines as well. Someone who bought 100 shares of Coca-Cola stock in the past year at $40 per share and is now sitting on 104 shares, would encounter his nominal break-even point at $38.46. There is always regular buzz about the next recession or stock market decline, but even for the Coca-Cola investor of the past year who bought at $40 per share, it would require a 21.5% decline in the price of the stock for a paper loss to result. Acquiring a cash-generating business and letting that thrown off cash acquire additional shares is probably the fourth most important thing you can do in life, behind maintaining your health, a specialized skill set in the employment markets, and a successful marriage.
Originally posted 2018-12-09 10:01:04.