Well, look what we have here. Coca-Cola (KO), the signature example of dividend growth investing, and a staple of long-term portfolios for men like Charlie Munger and Donald Yacktman has found itself fairly valued at under $39.26 per share as of Friday's close. Ideally, investors would like to buy excellent companies at a discount, but for a company like Coca-Cola, that is not particularly a feasible option.
The reason why Coca-Cola never seems to go on sale is because a company's growth prospects and earnings quality are the two primary drivers of a company's fair value. When things are going well in the economy, investors will focus on Coca-Cola's reliable 8-12% earnings per share growth, 30% return on equity, penetration in international markets, etc. to find a reason to put the company in the portfolio. In other words, Coca-Cola represents a global growth story in good times.
When things are going poorly in the economy, the price of Coca-Cola tends to hold up quite well because investors then choose to focus on the high earnings quality of Coca-Cola instead. Instead of focusing on its growth, investors focus on the safety inherent in a company that maintains profits in all economic conditions, has over 500 brands under its corporate umbrella, has been raising dividends every year for over half a century, and does so with such predictability that investors know they will be getting an income increase declared by the Board of Directors in February of each year.
Nothing is guaranteed in this world, but we have to place our bets somewhere, and it is hard to think of a company with a more predictable likelihood of giving investors an income increase in troubled times than Coca-Cola stock.
From a consistency perspective, Coca-Cola's business performance has been pure investing poetry. Since 1999, the Atlanta beverage maker's cash flow per share has increased every year single year except for one. And that was the 2008-2009 stretch when cash flow per share treaded water from $1.79 to $1.75 per share. Other than a four cent drop during the worst economic catastrophe since The Great Depression, you got to watch the intrinsic value of your holdings expand right before your very eyes. This manifested itself in a dividend that went up every single year during that time frame.
When you look at Coca-Cola's long-term performance, it has rarely been the business performance of the company that has caused shareholders to experience inadequate returns. Rather, it has been investors grossly overpaying for an ownership stake in Coca-Cola's profits that caused them to do poorly. You have to find moments in time like 1998 when Coca-Cola traded at 60x earnings to find an entry point when Coca-Cola would have been an unsatisfactory investment.
It is not paying 20, 21, 22, or 23x earnings for Coca-Cola that gets investors into trouble. I'll show you what I mean:
If you paid 22.6x earnings for Coca-Cola in June 2003, you would have achieved annual returns of 8.7%.
If you paid 22.5x earnings in 2004, you would have gotten 8.0% annually.
If you paid 19.7x earnings in 2005, you would have generated 10.6% annually.
If you paid 18.5x earnings in 2006, you would have posted 12.0% annually.
If you paid 21x earnings in 2007, you would have returned 10.2% annually.
If you paid 17.8x earnings in 2008, you would have gotten 10.1% since then.
If you paid 16.6x earnings in 2009, you would have generated returns of 16.1% annually.
If you paid 16.2x earnings in 2010 for your shares, you would have made 18.9% annually.
If you paid 17.4x earnings in 2011, you would have gotten 12.2% annual returns.
And if you paid 18.8x earnings last year, you would have gotten 9.5% returns since then.
If you think we are headed for another economic catastrophe in the near future (a la 2008-2009), then it would make sense to wait for a better entry point with Coca-Cola. As we know from basic math, the lower the price you can get for an asset, the better the returns, all else equal.
But here is the thing. From 1982 to 1999, the S&P 500 only had one down year. That was in 1990 when the S&P 500 declined 3-4%. Other than that, it was up, up, up. Other than the bear market of 1973-1973, the crash of '87, and the 2008-2009 recession, it is difficult to find a moment when Coca-Cola got crazy cheap. When an asset grows earnings nine years out of ten and increases dividends ten years out of ten, it creates some rationality in the market place that prevents the company from getting cheap because we all know how excellent it is. The good news is that investors can still pay 20-23x earnings and get 8-10% total returns over the long-term.
It is not just the fact that Coca-Cola delivers good returns that make it an attractive investment, but rather, it is the style of how the company gives you total returns. The earnings are almost always growing, allowing you to witness business performance growth in real time.
Additionally, the company offers two safety valves that encourage you to hold through tough economic climates: first of all, it is a widely accessible product. If the stock falls to $20 per share, all you have to do is go to Wal-Mart and watch people load their carts with Coca-Cola, Diet Coke, Sprite, Powerade, etc. to realize that you still own an excellent asset, regardless of what other stock market participants are doing at a given time.
And you also get to see the dividend grow up each year. It's great building a portfolio with a strong backbone. It is awesome having an asset on your personal balance sheet that you can rely upon to pay you more and more dividends each year than the last. As Charlie Munger is fond of saying, drowning in income is fun.
That is what makes Coca-Cola return to the 20x earnings mark seem so exciting. It's a company worth 19-21x earnings, based on present known risk factors and adjusting for growth rates and earnings quality. This is an opportunity to follow the wisdom of buying a wonderful company at a fair price. If you choose to initiate a position, you become a part-owner in a company that increases profits like clockwork, raises dividends every single year (with a half-century record to prove it), and has over 500 brands under the corporate umbrella. That's a formula for success that is hard to screw up.