Almost twenty-five years ago, Warren Buffett began making his substantial investment in Coca-Cola (KO) stock that has taken care of Berkshire Hathaway (BRK.B) shareholders ever since. To date, Berkshire currently owns 200,000,000 shares of the Atlanta-based soft drink giant—and since there are 2.3 billion shares of the company outstanding, this brings Berkshire’s overall investment to about 8.7% of the company overall. To put that in more visual terms, anytime someone in the entire world buys a twelve-pack of Coke, Diet Coke, Sprite, Fanta, Minute Maid, Powerade, or Desani, Berkshire Hathaway has an ownership claim to the profit from one of those twelve. This alone gives Buffett a very nice self-sustaining economic engine to work with—he receives $94 million each quarter in dividends from Coca-Cola to reinvest as he wishes.
When it comes to the Pepsi/Coca-Cola debate, it’s clear which side Buffett has chosen. Regulars who attend the Berkshire Hathaway annual shareholder meeting know that Buffett often peddles Coca-Cola products as he sips from the Cherry Coke that is always present at his side. As his friends and colleagues like to joke, “Warren doesn’t have a blood stream. He has a cherry coke stream.” So it seems fair to say that Buffett has reached the point of no return with his Coca-Cola investment.
But I do think this is worth considering—if Buffett didn’t already own a quite substantial stake in Coca-Cola, would he necessarily choose an investment in Coke over Pepsi? The traditional wisdom would indicate yes. The days of the 1980s when Pepsi would hold even with Coke in the grocery aisles, even to the point where Coke felt defensive enough to make blunders like ‘New Coke’, seem to be over. Pepsi has loaded itself with more debt than Coke, and seems to be losing ground to Coke in the all-important emerging economies where Coke is saturating the markets to such an extent that Diet Coke has now passed Pepsi as the #2 global soft drink behind Coke. And it does seem that Coke’s management has more of a magical touch of late than Pepsi’s.
But those factors do not necessarily mean that Buffett would prefer Coke to Pepsi at this point in time. As his late mentor Benjamin Graham would often preach, every investor must ask himself the question, “On what terms and at what price?” A cursory glance at Coke, trading at about $67.50, might show up in stock screeners as trading at 12.5x earnings. This is misleading, because the revaluation of Coca-Cola Enterprise Shares (CCE) has given Coca-Cola a one-time source of profit, $5 billion dollars, that skews the numbers. If you remove one-time sources of earnings, Coca-Cola is really trading around 17.5-18x earnings. Pepsi, meanwhile, has been in a bit of a rut from a stock price standpoint this year (which is a good sign for anyone who wants to be a net-purchaser of PepsiCo shares for the long haul), seeing its shares fall from $71.89 to just under $62 per share, for a price of 15.50x earnings. For Coke investors, the current earnings yield is about 5.65%, and for Pepsi, it is 6.45%.
Pepsi currently offers investors a 3.32% dividend yield, and Coke currently offers investors a 2.77% dividend yield. Pepsi has raised its dividend by 11.0% annually for the past ten years, and Coke has raised its dividend by 10.0% annually over the past decade. Pepsi’s current dividend payout ratio, based on 2011 projected earnings, is 47.3%, and Coke’s is 48.5%.
If all things are equal, Pepsi appears to be slightly cheaper than Coca-Cola based on current evaluations. But, of course, all else isn’t equal. If you think that there is a high probability that Coke will continue to increase its lead over Pepsi internationally, and therefore attain higher growth, then it may be worth giving up that 1% difference in earnings yield and 0.5% difference in dividend yield in order to buy shares of KO. But if you think the pendulum is going to swing the other way, and Pepsi is going to narrow the gap between itself and Coke and perhaps pass Diet Coke to again be the #2 soft drink in the world—or if you think the snack food brands will add additional ballast to Pepsi’s bottom line—then loading up on shares of Pepsi might be wiser. Most people, when making a reference to Coke’s saturation in international markets, see that as a reason to load up on Coke shares. Personally, I think of it in terms of growth—Pepsi has yet to expand internationally in a manner even approximate to Coke’s, and if they can tap those markets successfully (which is a medium-sized if), then that might give Pepsi an avenue for growth advantage over Coke. But most of this is small quibbling—Coke and Pepsi are two of the best long-term holdings any investor can add to his portfolio, and if you can get your hands on shares of Pepsi for below $60 or Coke below $63-$64, I’m sure you’ll do quite fine over the coming decades.