In his 1993 letter to shareholders of Berkshire Hathaway, Warren Buffett provided an interesting historical aside about Coca-Cola’s long-term performance:
“Let me add a lesson from history: Coke went public in 1919 at $40 per share. By the end of 1920, the market, coldly re-evaluating Coke’s future prospects, had battered the stock down by more than 50%, to $19.50. At year-end 1993, that single share, with dividends reinvested, was worth more than $2.1 million. As Ben Graham said, ‘In the short-run, the market is a voting machine—reflecting a voter-registration test that requires only money, not intelligence or emotional stability—but in the long-run, the market is a weighing machine.”
For those of you who are curious, that share is now worth either slightly below $10 million or slightly above $10 million depending on the latest market fluctuations.
What I picked up from Buffett when I first came across this passage is the fact that volatility is not a proxy for risk. This is the mistake that 99% of new investors make, and if you reach a point in your life where you think solely in terms of business performance (and not stock price changes), the world is yours.
Charlie Munger, Buffett’s right-hand man at Berkshire, is famous for saying that if you cannot handle the thought of a given stock falling 50% in price, you shouldn’t be in the market. It’s happened four times since Buffett and Munger took over Berkshire. Heck, it’s even happened to an excellent business like Coca-Cola on at least three occasions since its 1920 IPO that I am aware of—there could be more. If you are thinking in terms of an investing lifetime (say, from your 20s through 80s), you should be prepared to see the paper net worth of your holdings fall by 50% on at least four different occasions over that time stretch.
But here is where things get interesting for long-term investors: if you think in terms of underlying business strength instead of volatility, things are much, much smoother. From 2008 to 2009, the stock price fell from $32 to $20. On paper, it looked like you saw a decline of around 40%. This is what scares people, causes them to sell low, and is the perfect strategy if you want to destroy years and years of wealth accumulation in a very short period of time.
If, however, you want to become one of those long-term investors that executes a buy-and-hold strategy that ends up becoming richer even through the passage of recessions and depressions, then I encourage you to focus on business performance. In 2008, Coca-Cola gushed out $1.51 in profits per share. In 2009, the company generated $1.47 in profits per share. We experienced the worst economic catastrophe since The Great Depression, and Coca-Cola’s profits only declined $0.04 per share. That’s practically a rounding error!
Oh, and the company managed to raise its dividend from $0.76 annually to $0.82 annually. This should come as no surprise. If you could go back in time to 2008 and 2009, you would still see people ordering Coca-Cola at McDonalds. You would still see them drinking Sprite at a restaurant. You will still see kids drinking Powerade on the sidelines of a basketball game. When you sell a well-branded, low-cost product in 207 countries that earns 30% returns on equity, you’re going to be around for a long time.
There is a reason why Warren Buffett doesn’t touch the 400,000,000 shares of Coca-Cola in his portfolio. The profits go up each year. The dividends go up each year. The company has well-protected and well-protected trademarks, and over 500 brands in its portfolio. Think about what your life starts to look like when you have a 500 share block of stock like that during your working life. You get a check every ninety days, and it goes up every year. Like clockwork. What’s not to love?
There is a lot of wisdom in Buffett’s quote listed above. Screw market volatility. Worrying about stock prices and sweating the changes on the ticker screen is what messes people up and destroys wealth in a hurry. Find the companies that generate gushers of profit even in terrible economic conditions, and spend your life acquiring shares of them. Then, you get a dividend check every ninety days. Once you own twenty to thirty of them, you will be getting money deposited into your account anywhere between 80 and 120 days per year. Twice a week, money could be flowing into your checking account. You get to construct your life how you want. Who cares about stock prices when you are getting cold, hard cash profits deposited into your checking account on a very regular basis? Why wouldn’t you want to live like that?
Originally posted 2013-07-14 05:58:52.