Why Coca-Cola Is Warren Buffett's No. 1 Holding

| About: The Coca-Cola (KO)

Generally speaking, I’m a big fan of consumer staple stocks because they strike me as "no-brainers" that have a place in the portfolio of almost every investor. When I look at companies like Coca-Cola (NYSE:KO), PepsiCo (NYSE:PEP), Johnson & Johnson (NYSE:JNJ), Proctor & Gamble (NYSE:PG), and Colgate-Palmolive (NYSE:CL), I see companies with strong brand names, strong economic moats/enduring competitive advantages, and large profitability. It’s no wonder that Coca-Cola, Johnson & Johnson, and Proctor & Gamble each occupy a significant portion of Buffett’s overall portfolio.

Let’s take a look at the durable advantages of Warren Buffett’s largest holding in his investment portfolio, Coca-Cola (KO). First of all, Coke would most likely have to make some seriously foolish mistakes to ever become an unprofitable company. Its brand name is a tremendous advantage that ensures customers will pay a premium for Coca-Cola products, which contributes meaningfully to the company’s bottom line. Let’s say I start a soda company called "Mr. Tim’s Sugar Water" with the intention of competing with Coke. I would be at a significant disadvantage right away since Coke has global economies of scale that would give it the edge in controlling costs much better than a small-scale startup. It would probably cost me around a dime to produce my syrup concoction whereas I doubt it would cost Coke more than $0.03-$0.04 to create their trademarked syrup. Before even trying to compete with Coca-Cola in the marketplace, I’d be at a wide disadvantage in terms of initial costs.

Likewise, it’s incredibly difficult to disrupt a company that has name-brand recognition in the low-end luxury good market. People have a natural bias to gravitate towards the names that they are already familiar with. Even if Mr. Tim’s Sugar Water sells for $0.50 and Coke sells for a $1.00, most customers would be unlikely to try anything new, so they’d shell out the extra $0.50 for Coke. I’m sure this is a main reason why Buffett owns Coke — even if a burgeoning competitor tried to sell a product for a lower price than Coke, it is unlikely that Coke would lose market share to the upstart.

While Coke does appear insulated from emerging competitors, it does have to deal with two entrenched adversaries in PepsiCo and Dr. Pepper Snapple (NYSE:DPS). Even though Coke has been dominating Pepsi in terms of market share in recent years, both companies have such a dizzying array of product offerings that neither company has the power to deliver a knockout blow to the other. Coke’s diversified product line-up includes: Coca-Cola, Diet Coca-Cola, Fanta, Sprite, Fresca, Mr. Pibb, Dasani, Vitamin Water, Minute Maid, and the Powerade brands. KO offers a nonalcoholic beverage for seemingly every occasion, and their entire product lineup boasts an impressive 20% profit margin on the whole.

Buffett recently said about Coke that, “Time is the friend of the wonderful business” and it’s easy to see why he says that. Buffett has maintained his 200,000,000 share stake in KO throughout the entirety of the decade. In 2001, those 200,000,000 shares gave Berkshire Hathaway (NYSE:BRK.A), (NYSE:BRK.B) a claim on $320 in overall ownership earnings which paid out $144 million in annual dividends to Berkshire. Buffett hasn’t raised or lowered his 200,000,000 stake, and now those same Coca-Cola shares represent $770 million in annual earnings which pay out $376 million in annual dividends to Berkshire’s headquarters this year. That’s not bad — over this ten year stretch, Buffett now receives more in cash dividends from Coke than the ownership earnings that his shares represented in 2001.

It’s no wonder Coca-Cola is Buffett’s largest holding. It has a wide moat over competitors that face a significant barrier to entry; it has a very strong brand name that ensures customers will pay a premium for its products, and most importantly, it is a disposable luxury good that people will keep on buying, over and over again. And because management has used profits to buy back shares, Buffett’s overall ownership stake in the company continues to increase. Every time you pay a dollar for a nice can of Coca-Cola, Warren Buffett collects a dime from you.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.