Today was an interesting day in that I made the biggest one-time shift in general portfolio composition that I have ever made all at once. I sold all of my utilities and REIT holdings, and with the addition of available cash to invest, stuffed it all into a holding of Coca-Cola (NYSE:KO) purchased at just under $40 per share.
The logic was this: each of my utility and REIT holdings were trading at valuations only seen once or twice in the past twenty years, with some of that trading at all-time highs. The 30% and 40% annual returns I had experienced with them seemed like something out of a "get rich quick scheme" territory rather than something you ought to experience with stodgy real estate and utility holdings.
It's one thing to see P/E ratios expand due to a rational basis: a cleaner balance sheet, higher earnings quality, or brighter future growth prospects. It's quite another to see electric and water companies doing the same 'ole, same 'ole and charging investors a 33% premium compared to this time last year. Owning a stock at 20x earnings that grows at 6-7% each year is something I get. Owning that same stock at 30-35x earnings and still growing at that same 6-7% is something I understand a lot less.
Meanwhile, in a world of overvalued securities and historically high premiums, Coca-Cola is sitting there right in plain sight, at a fair valuation of 20x earnings. One thing has always caught my attention about Coca-Cola is that the only time "it fails" as an investment is if you pay an absurdly high price. Investors paid 50x earnings for Coca-Cola in 1998, so it is no wonder the returns are only 3.82% since then. That is a vindication of sound investing principles rather than a repudiation of them; you're not supposed to do well when you buy mega-cap companies with 2% earnings yields because the growth of the company gets smacked by the headwind of a company's valuation moving down from 50x profits to 20x profits.
But for sensible investors that demanded fair value when purchasing Coca-Cola stock, the returns worked out much better. If you bought Coca-Cola stock when its valuation hit 20x earnings in 2004, you would have 10.73% annual returns through today. If you insisted on buying Coca-Cola at 20x earnings in 2005, you'd have 11.82% total returns through today. If you had the same discipline in 2006, you'd have 10.21% returns through today. In the post-millenium era of investing, things have tended to work out quite well for Coca-Cola shareholders when you insist on the discipline of paying 20x earnings to make your investment. With Coca-Cola sporting an earnings power of $2.10 per share, it's hard to see how you cannot recreate the same magic by buying shares below $42 each.
In a lot of ways, this investment has been a long-time coming. If there is one thing that you're supposed to do as a long-term investor, it is hold a block of Coca-Cola stock as you go through life. There is no single investment in this country that is more famous and well-documented than the 400,000,000 shares that Warren Buffett has put under the umbrella at Berkshire Hathaway. If you read Charlie Munger's biography (Damn Right! by Janet Lowe), you will encounter several passages where Munger takes over an institutional fund for a charity or a hospital and the first decision is he makes is putting at least 10% of the assets into Coca-Cola stock. You have Donald Yacktman showing up on CNBC interviews saying now is the time to buy Coca-Cola, and if you look at the decisions of the Yacktman Fund lately (which is being handed over to his son Stephen), you see an incessant, growing allocation of Coca-Cola in the portfolio.
Yes, I understand that it is currently fashionable to bash Coca-Cola for reduced volume trends for soda-drinkers in North America. But to me, that is a narrow analysis: I like to look at what the entire company is doing, for all of its operations across the world. Volumes are actually increasing 2% annually when you expand your analysis to include global operations of all beverages under the Coca-Cola corporate umbrella. And plus, profits are still growing from $1.97 to $2.10 over the past twelve months. If a company has a "bad year" and the profits still increase 6.59%, count me in.
In some ways, it took me way too long to make Coca-Cola one of three central stocks in my portfolio. Profits have increased in 76 of the past 80 years. The company has returned more and more cash to shareholders for 50 years running. Wealth gets built at a 10% or better rate for shareholders that build their stakes at 20x earnings or less. The investors that I respect the most own large chunks of the stock. It has one of the five most well-known trademarks in the world. It would cost more than $100 billion to replicate their distribution networks from scratch.
In sum, you've got a good valuation, the halo of well-known investors endorsing it, a record of increasing dividends for half-a-century, profit growth in just about every year for eight decades running, a very famous trademark, and 30% returns on equity that are the result of spending a few cents on a product that ends up getting sold for over a dollar. I'll happily take that over REITs and utilities trading at the highest valuations ever while interest rates are at generational lows. It was probably a mistake that I did not make this maneuver sooner.