Share a Coke with Warren Buffett

This company needs no introduction. Approximately 74% of sales and 77% of profits came from outside North America in 2007. Coke (KO) is one of the most consistent and predictable consumer stocks available today. Including the just concluded 2008, EPS grew in 17 of the past 19 years with the last negative year-over-year period coming in 1999 when earnings were off from $1.42 to $1.30. Since then each of the nine years has shown growth with EPS expected to have come in at $3.12 for the year ended Dec. 31^st.

Consensus estimates revolve around $3.27 - $3.29 for 2009. That puts KO shares at just 14.3x last year's and < 13.7x forward earnings. This is the lowest valuation of these shares since just after the crash of 1987. In fact, the 10-year median P/E was (in my view) an excessive 26x and the 5-year average annual P/E from 2003 – 2007 was 20.9x.

Berkshire Hathaway owned 8.6% of the shares as of last March's proxy statement.

Coke's current yield of 3.41% is the highest in about 20 years mainly due to steady earnings and dividend increases while the share price has gone nowhere.

Value Line rates KO's financial strength as 'A++' and notes its 'stock price stability and 'earnings predictability' are both in the 100th percentile of their 1700 company research universe (with 100^th being best). It also earned a #1 (best) 'safety' rating.

Here are the impressively consistent per share numbers from the past few years as reported by Value Line. 2008 figures include Q4 estimates:

Year ….. Sales ….. C/F….. EPS ….. Div…… ..B/V ….... Avg. P/E

2002 ….. 7.92 ……1.99 ….1.65 ….. 0.80 ….. 4.78 ……. 30.2x

2003 ….. 8.62 ……2.31 ….1.95 ….. 0.88 ….. 5.77 ……. 22.6x

2004 ….. 9.12 ……2.45 ….2.06 ….. 1.00 ….. 6.61 ……. 22.6x

2005 ….. 9.75 ……2.59 ….2.17 ….. 1.12 …...6.90 ……. 19.7x

2006 ….10.39 ……2.81 ….2.37 ….. 1.24 …...7.30 ……. 18.5x

2007 ….12.45 ……3.08 ….2.57 ….. 1.36 ….. 9.38 ……. 21.0x

2008 ….14.22 ……3.62 ….3.12 ….. 1.52 …..10.75 …… 17.3x

If you assume a forward P/E of even 16 on year ahead estimates of $3.27 you get a 12-month target price of $52.32 or + 17.3% above the current quote. Add in the $3.41% yield and this very conservative holding could easily show a one-year total return of 20.7%. How does that look to you versus today's t-bill and CD rates?

Want an even lower risk way to play Coca-Cola?

How about this:

…………………………………………....Cash Outlay …….. Cash Inflow

Buy 1000 KO @$44.60 ………………….$44,600

Sell 10 Jan. 2010 $45 Calls @ $5.50 ………………………….$5,500

Sell 10 Jan. 2010 $45 Puts @ $6.50 …………………………..$6,500

Net Cash Out-of-Pocket ……………..…..$32,600

At expiration date (Jan. 15, 2010) if KO shares are $45 or higher (just 1% above our starting price of $44.60):

• You will have no further option obligations.
• Your $45 calls will be exercised.
• You will sell the shares and collect $45,000.
• Your $45 puts will expire worthless (a good thing for you as a seller).
• You will have $45,000 plus $1,520 in dividends = $46,520 cash for your original net cash outlay of $32,600.

That's a 42.7% cash-on-cash return in 12.4 months on shares that only had to be up 1% from your starting point.

What's the risk?

If KO shares are below $45 in January 2010 you will be forced to buy an additional 1000 shares for $45,000 more cash. You would then own 2000 shares of KO total.

What's the break-even on this trade?

On the original shares bought at $44.60 it's that price less the $5.50 /share call premium = $39.10 /share.

On the $45 puts it's the Strike Price of $45 less the $6.50 put premium = $38.50 /share.

Thus your overall breakeven is the average of those two prices = $38.80/share. You will not be hurt unless KO shares drop by more than 13% from your starting price of $44.60.

While nobody can assure you that KO shares will not be below $38.80 in early 2010 I can tell you that Coca-Cola shares had absolute low prices of $40.30, $39.40, $45.60 and $40.29 in 2005, 2006, 2007 and 2008 (including the panic sell-offs in October and November). The dead low in 2004 was $38.30 when EPS were $2.06 or 33.9% under those of the just completed year.

For a more aggressive combination I'm using the $50 calls and $50 puts and the 2011 expiration cycle.

Disclosure: Author is long KO shares and short KO options.

Comments

[notsosmart:]

is this investing or gambling? what a sad joke this has all become.

Jan 09 04:14 PM

[jepittman:]

You know your question reminds me of my old undergraduate finance class teacher's definitions of 'gambling' and 'speculation' as it refers to the financial markets. It has been a long time and I can't give an exact quote but it went something like this: If two flies light on a cube of sugar ant two people bet on which fly leaves first, that is gambling because no good or service is rendered to anyone. However if an investor buys a share of common stock hoping it will trade higher and thus can be sold for a profit, that is (legitimate) speculation because liquidity has been provided in the marketplace, which is a service to others.

Now frankly, a lot of people are starting to look around for ideas (speculative and otherwise) because yields in CDs and such are so low and likely to stay that way for quite a while. So it appears to me the author's post is a pretty good one.


On Jan 09 04:14 PM notsosmart wrote:

> is this investing or gambling? what a sad joke this has all become.

Jan 09 05:16 PM

[Paul Price:]

NotsoSmart,

Why would buying a high-quality, good yielding stock and holding it for a bit over one year to make over 42% be gambling?

Jan 09 09:08 PM

[Glen Bradford:]

He's not so smart. You can't expect everyone to make good decisions. Those that make good decisions are called outperforms, lucky ducks, and smart.

I prefer Pepsi to Coke as a vehicle of investment. It's cheaper with greater growth. Look to the historical return on Pepsi vs. Coke and imagine how far Buffett would be ahead if he came across Pepsi bottle caps in the streets of Omaha.

Jan 10 11:09 AM

[{5U}:]

HAHAHAHAHAHAHAHAHAHAHA...

The man has made billions. Is that what they are teaching in MBAs nowadays?

No wonder we have a financial crisis!!!!


On Jan 10 11:09 AM Glen Bradford wrote:

> He's not so smart. You can't expect everyone to make good decisions.
> Those that make good decisions are called outperforms, lucky ducks,
> and smart.
>
> I prefer Pepsi to Coke as a vehicle of investment. It's cheaper with
> greater growth. Look to the historical return on Pepsi vs. Coke and
> imagine how far Buffett would be ahead if he came across Pepsi bottle
> caps in the streets of Omaha.

Jan 10 01:19 PM

[Paul Price:]

To be fair, I think Glen B. was referring to the earlier blurb from 'NotSoSmart' rather than to Mr. Buffett's choice of investing in Coke over PepsiCo.

Jan 10 08:29 PM

[ROBOT 1:]

Lets see what happens to KO and the stock when Obama goes after American Firms hiding money in the Cayman Islands .

Jan 12 06:34 PM

[Paul Price:]

Dividend Machine,

Aren't you the same guy that was exposed as submitting multiple entries on your own website under many different aliases?

Your website is a joke and is clearly dying.

That wouldn't be true if you offered any value to people who visited.

Jan 14 02:58 PM

[Glen Bradford:]

Yeah, I was referring to the person Notsosmart

But, then i simply suggested investing in pepsi instead of coke.

Actually, Buffett would be ahead of the game if he'd done this.

I learn most of what I consider to be applicable knowledge outside of the classroom. In the classroom --- it's just how to be a good employee. The trick is translating the classroom material into being more than just a member of a system --- that is to say the person that owns the system.


On Jan 10 01:19 PM Equity Has No Clue wrote:

> HAHAHAHAHAHAHAHAHAHAHA...
>
> The man has made billions. Is that what they are teaching in MBAs
> nowadays?
>
> No wonder we have a financial crisis!!!!

Jan 15 02:36 PM