Five years ago, Coca-Cola stock hit a high of $45 per share. Right now, the stock trades at $47.85. When any stock does not appreciate in price for five years or more, the investor class often allows their analysis to succumb to recency bias. That is to say, if Coca-Cola had the exact same business that is operating now but the price of the stock was, say, $80 per share, the analysis of Coca-Cola’s present circumstances would be far rosier than is currently on the case.
In theory, we should be able to avoid recency bias by reminding ourselves that the value of any business today is contingent upon the net present value of all future profits that the business generates capitalized at some multiple on the end date of your contemplation period. Remembering this lesson has served the investors in iconic companies such as Johnson & Johnson and the pre-spinoff Abbott Laboratories quite well, as both of those stocks had eight-year periods of no price appreciation in the early 2000s before going on to deliver market-beating returns from the original date of the price stagnation to the present.
When I study Coca-Cola, I find myself looking at a company that has become much stronger over the past five years even if the earnings per share growth has been non-existent (Coca-Cola earns $2.10 per share in profit now which is what it was earning in 2014).
What people don’t realize is that the company has gotten much stronger in the meantime. Coca-Cola, already boasting the best beverage distribution network in the entire world, has entered into licensing agreements with the likes of Dr. Pepper Keurig and Anheuser-Busch Inbev to distribute their beverages for a fee while also reducing the likelihood that its most logical competitors could build a distribution network that could seriously rival their own.
Financial analysts, which largely consist of young guys less than five years out of college who are rushed to get out their report on Coca-Cola to their clients, lazily report that Coca-Cola is a declining brand on the basis that it has experienced “unit case volume” declines over the past twenty years, missing the point that unit case volume is a standardized term that signifies 24 eight-ounce servings of finished beverage which obfuscates the reality that Coca-Cola is now selling far more mini-servings of its product compared to two-liters.
If these guys dug into the numbers, they’d realize that Coca-Cola (as in, Coke, rather than the company) consumption is actually up 4% since 1999 and each ounce of the serving is generating 132% higher profits over the same time frame. Really, the stock’s mailaise is due to the fact that Diet Coke rose in prominence during the 1990s, the upper and middle class discovered the harmful effects of aspartame, and sales of Diet Coke plunged more than 30% over the past twenty years as the company has underinvested in advertising for the diet brand that the Western World had come to reject.
The fair analysis is that Coca-Cola has been offsetting the decline of Diet Coke and the immense cash drains on the reshuffling of its franchising efforts with bottlers and is now positioned for 6-7% annual growth. With a 3.3% dividend, that is a likely range of 9.3% annual returns with no dividends reinvested to returns in the 11% ballpark with dividends reinvested.
In a world where some companies grow 6-7% in a quarter, let alone a year, what’s the appeal of Coca-Cola? It is easy to forget when we are ten years into an uninterrupted bull market, but the whole point of portfolio construction is to balance high growth investments along with investments whose businesses could maintain their underlying profits if the world were to turn to hell before you even realized what happened.
Coca-Cola was the business that grew profits during the Great Depression. It allowed a bunch of old farmers in Quincy, Florida to gobble up hundreds of acres of farmland for pennies on the dollar when Coca-Cola dividends rolled in at a time when no other money could be found. It “formalized” its dividend payouts in 1963, and has grown them every year since. The crisis in 1973-1974, the extreme one-day collapse in 1987, the recession of 2008-2009, you name it, and Coca-Cola has been there to provide.
Most of us are able to invest based on savings from labor. One of Charlie Munger’s key life maxims that is simple to say but harder to implement at all times is the notion that we should avoid putting ourselves in “go back to go” types of situations. You don’t want your assets to go bankrupt or collapse and undo years of delaying gratification and spending less than your labor would have otherwise permitted.
It follows then, that the best investments are those that create wealth while simultaneously maximizing safety. U.S. Treasury bonds and several other government bonds are tremendously safe because they are backed up by taxing power over the earnings of an affluent and populous base, but the returns range from 2-4% and barely maintain purchasing power let alone increase it.
With Coca-Cola, investors have the opportunity to build real wealth while also finding safety in owning a company that distributes 3% of the total liquid consumed in the world each day that is backed by extreme economies of scale and lowest marginal cost production and possibly the most valuable trademarks in the entire world.
When the price of a blue-chip stagnates for too long, even great businesses become neglected. What have you done for me lately cannot be conflated with what will you do for me in the future. The safest, highest-quality business in the world can be had at the low end of fair value. Collecting dividends that rise each year among capital appreciation of roughly double inflation is a great prospect when evaluated in the context of the high certainty that it will occur amidst any economic condition imaginable.