Coca-Cola, Ten Years and Still No Growth

July 10, 2007 by Joe Ponzio

If you bought Coca-Cola (ticker: KO) on January 2, 1996 and held it through December 29, 2006, you would have had a 10% gain, or about 0.92% average annual return for ten years (when factoring in dividends). Sure, you would have had some big ups and downs, but stock prices generally follow value in the long run. Knowing that, investors could have avoided a lackluster return with just a few minutes of work.

First, let’s take a look at the value of Coca-Cola’s business at the end of 1996. You can follow along by looking at the 1996 spreadsheet:

From 1987 though 1996, KO grew Free Cash Flow a median rate of 16.2%. Stellar. In addition, it generated roughly $0.42 of cash for every dollar of invested capital. Even better! Shareholder equity was growing at about 8% which isn’t that great. Still, we can put a value on the company.

Getting Coca-Cola’s 1996 Value

Shareholder equity plus our estimation of the future Free Cash Flow gives us a value of $75,752 million. Divide that by the number of outstanding shares at the end of 1996 gives us a per-share value of $30.42. But Coca-Cola never hit $30.42, let alone our target price of $22.84 when factoring in a 25% margin of safety. In 1997, Coca-Cola’s stock traded between $50 and $72.62, well above the value of the company.

One of three things had to happen:

  1. Coca-Cola’s value would rise quickly to justify the high price; or,
  2. The price would have to hold steady until Coca-Cola’s value crept up to it; or,
  3. The price would have to drop to a level more consistent with Coca-Cola’s value.

On a daily and monthly basis, price can do anything. Over the long-term, price follows value.

What to Do With Coca-Cola In 1996

The goal of long-term investing is to buy a wonderful company at a fair or bargain price. In the case of Coca-Cola, investors were buying a business at a high price-well more than the company was worth if an investor wanted to earn 15% or more on an annualized basis.

The long and short of it is simple: You can’t overpay for a business, and then be surprised when you lose money (or don’t make a lot). In the case of KO, you could have speculated on its stock price and made some money, but you could not have reasonably expected to be a long-term, stellar-return holder of KO’s stock when buying it in 1996.

Fast Forward to 2007

As it turns out, Situation Two (above) occurred-the stock price moved up and down greatly from month to month, but the long-term price held fairly level at the 1996 price. You can see a chart of its price movement (using end-of-day prices). The red dashed line connects the 1996 price to the end of 2006 price.

What about Coca-Cola’s value? Here’s the 2006 analysis.

The value hasn’t changed much-from $30.45 a share at the end of 1996 to $30.85 a share at the end of 2006. Price follows value, so it is no surprise to see that Coca-Cola’s price, on a long-term basis, barely moved an inch.

But Coca-Cola Grew!

Yes, Coca-Cola’s net worth grew by more than $10 billion. If you bought KO in 1996 and it shut down in 2006, you would be entitled to your fair share of that extra $10 billion. But Coca-Cola isn’t shutting down and the value of the company is not simply its net worth.

Coca-Cola has a value as an ongoing business-its intrinsic value. Though its “break-up” value grew from 1996 through 2006, its intrinsic value, and hence its value, as an ongoing business stayed fairly flat.

Did Mr. Buffett Screw Up With Coca-Cola?

Warren Buffett bought Coca-Cola in 1988, back when the company was growing rapidly. If our valuation methods are similar, he likely projected ten years of great growth from 1989-1998, followed by ten years of slowed growth.

During the first ten years, Coca-Cola’s free cash flow grew roughly 12.7% a year and its shareholder equity grew 9.9% a year. With Mr. Buffett’s margin of safety, his investment grew much more rapidly.

Remember that Warren Buffett bought Coca-Cola back in 1988 when it was a very attractive company selling at a fair price. That was nearly 20 years ago. Today, Coca-Cola is not as attractive and not selling at a fair price. Does Buffett care? Sure, he’d love to see all of his companies growing rapidly forever.

Will he sell? Probably not. He likely paid for 20 years’ worth of growth. Anything beyond that simply adds to his wealth. So long as Coca-Cola is growing, no matter how quickly or slowly, he probably won’t be going anywhere.

So no, he didn’t screw up.

What It All Adds Up To

At any given time, you could have made a little or a lot of money by speculating in Coca-Cola’s stock from 1997 through 2006. Traders and gamblers pushed the stock as high as $88.94 and as low as $37.01 during that time. The ones who got hurt were the long-term investors (and the gamblers on the wrong side of the trades).

A look at the business of Coca-Cola could have saved you ten years’ worth of ups, downs, and ultimately a flat return. Remember, buying stock is buying a piece of a business. If you don’t know the value of your business, you are simply gambling.

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