Coca-Cola: The Power Of A Good Dividend Company

Jul.23.12 | About: The Coca-Cola (KO)

A lot of people like to use history as a guide for judging investments, and on the surface it's difficult to fault this logic. If we know where a stock has been and where it is today, one can determine whether or not it has been a "good" investment. But of course agreeing on whether or not an investment was "good" has two inherent problems. First and foremost, while the past might give insights into the future, historical returns by no means set a precedent for upcoming potential. That is, while it might be nice to know that Apple (NASDAQ:AAPL) returned 75 times your money from 2003 to 2012, this in no way helps you to make a decision today.

Secondly, one cannot judge an investment in singularity. More specifically we must be able to compare our investments to their applicable opportunities. For example, just knowing that your investment had an average 6% return over the last decade doesn't tell you too much. If in the same period the market returned 2% a year, given the same level of risk, then your investment looks pretty attractive. On the other hand, if the market returned 12% annually, given the same level of risk, then your investments' "attractiveness" might fade. Although to be sure even this comparison would be incomplete. Let's look at an illustrative example to deepen our understanding.

Imagine that you have a stock price time machine. The date is July 1st of 1998. Although your stock price time machine is highly accurate, it only let's you see the future prices of two securities: Coca-Cola (NYSE:KO) and Berkshire Hathaway (NYSE:BRK.B). On July 1st of 1998 KO opens at $85.50 a share. On July 2nd of 2012 you see that KO is trading at $78.10, without splitting its stock. And you might think that this is some kind of tragedy. On July 1st, 1998 BRK.B opens at $52.26 (split adjusted). On July 2nd of 2012 you see that BRK.B is trading at $83.34. And you might think that this is some kind of triumph. After-all, we're in the market to make money rather than to lose it, correct? Berkshire Hathaway looks like a clear winner: an initial investment in BRK.B in 1998 would have returned an average price return of 3.65% a year, while an initial investment in KO would have returned an average price return of -0.69% a year.

However, there is a natural problem in impulsively announcing a better investment based on a couple of numbers. First, we haven't yet included dividends into the example. But more importantly, investors don't just invest everything at once and then sit on their hands hoping that they happened to pick the next Apple (AAPL). Rather, we invest regularly. Allow us to assume that an investor has the opportunity to invest $1,000 a year in either KO or BRK.B, knowing where the prices end up in 2012. Which would you choose? Of course we cannot make that distinction without doing the applicable math:

Coca-Cola (KO)
First Day Invested Price Shares Dividend $ Div Reinvest
1-Jul-98 $1,000 $85.50 11.69591 $0.30 $3.51 0.04
1999 $1,000 $67.00 26.66232 $0.64 $17.06 0.25
2000 $1,000 $58.00 44.15838 $0.68 $30.03 0.52
2001 $1,000 $60.94 61.08568 $0.72 $43.98 0.72
2002 $1,000 $46.80 83.17493 $0.80 $66.54 1.42
2003 $1,000 $44.15 107.2468 $0.88 $94.38 2.14
2004 $1,000 $50.80 129.0695 $1.00 $129.07 2.54
2005 $1,000 $41.90 155.4766 $1.12 $174.13 4.16
2006 $1,000 $40.79 184.1483 $1.24 $228.34 5.60
2007 $1,000 $47.80 210.6668 $1.36 $286.51 5.99
2008 $1,000 $61.45 232.9341 $1.52 $354.06 5.76
2009 $1,000 $45.40 260.7223 $1.64 $427.58 9.42
2010 $1,000 $57.16 287.6352 $1.76 $506.24 8.86
2011 $1,000 $65.88 311.6708 $1.88 $585.94 8.89
2-Jul-12 $78.10
320.56 shares 2012 Value $25,036.12
Click to enlarge

Here we made the assumption that the $1,000 would be invested on July 1st of 1998 and then on the opening trading day of each subsequent year until 2011. In total, we would invest $14,000. It is assumed that dividends are reinvested and for simplicity the 2012 dividends are used for "a night on the town." We see that a total periodic investment of $14,000 started in 1998 turns into a value of roughly $25,000 by 2012, despite the stock price "stagnating" for over a decade. The underlying reason behind this of course is the fact that the stock price dropped significantly in the middle years, along with the reinvestment of dividends. Personally, I would take solace in the fact that I could generate $9,000 in value from an investment that never reaches my initial investment's cost basis.

Let's check in to see how Berkshire Hathaway fared:

Berkshire Hathaway (BRK.B)
First Day Invested Price Shares Dividend $ Div Reinvest
1-Jul-98 $1,000 $52.26 19.13509 0 $0.00 0.00
1999 $1,000 $47.08 40.37554 $0.00 0.00
2000 $1,000 $36.50 67.7728 $0.00 0.00
2001 $1,000 $47.46 88.84317 $0.00 0.00
2002 $1,000 $49.80 108.9235 $0.00 0.00
2003 $1,000 $48.40 129.5846 $0.00 0.00
2004 $1,000 $56.30 147.3466 $0.00 0.00
2005 $1,000 $58.72 164.3766 $0.00 0.00
2006 $1,000 $58.50 181.4706 $0.00 0.00
2007 $1,000 $73.56 195.065 $0.00 0.00
2008 $1,000 $94.80 205.6135 $0.00 0.00
2009 $1,000 $64.10 221.2141 $0.00 0.00
2010 $1,000 $66.00 236.3656 $0.00 0.00
2011 $1,000 $80.50 248.788 $0.00 0.00
2-Jul-12 $83.34
248.78 Shares 2012 Value $20,733.99
Click to enlarge

As any Buffett follower knows, BRK does not pay a dividend. The same $14,000 was invested over the same time period. And while your initial investment did increase in value, along with all but one of your other $1,000 investments, your 2012 value is just under $21,000. To be sure value has been created, but given the option between regularly investing in KO or BRK.B over the time period, one would be both rationally and financially inclined to select the beverage behemoth. KO delightfully demonstrates the power of both a growing dividend and buying a wonderful stock at a cheaper price.

Now some might be clamoring that pitting a dividend growth company against a non-dividend paying company isn't directly comparable. I agree, so here's an illuminating example to underscore the point. Let's make up a company. The stock price of Made Up Inc. was $50 in 1998 and it currently has a dividend yield of 2%. (KO's was just 0.70% in 1998). Additionally, the price is expected to increase by 5% a year and then the dividend is expected to grow by 6% a year. Now which one do we choose? Of course the math makes that decision:

Made Up Inc.
First Day Invested Price Shares Dividend $ Div Reinvest
1-Jul-98 $1,000 $50.00 20 1 $20.00 0.40
1999 $1,000 $52.50 39.44762 1.06 $41.81 0.80
2000 $1,000 $55.13 58.38467 1.1236 $65.60 1.19
2001 $1,000 $57.88 76.85147 1.191016 $91.53 1.58
2002 $1,000 $60.78 94.88688 1.262477 $119.79 1.97
2003 $1,000 $63.81 112.5285 1.338226 $150.59 2.36
2004 $1,000 $67.00 129.8126 1.418519 $184.14 2.75
2005 $1,000 $70.36 146.7744 1.50363 $220.69 3.14
2006 $1,000 $73.87 163.4481 1.593848 $260.51 3.53
2007 $1,000 $77.57 179.8667 1.689479 $303.88 3.92
2008 $1,000 $81.44 196.0627 1.790848 $351.12 4.31
2009 $1,000 $85.52 212.0674 1.898299 $402.57 4.71
2010 $1,000 $89.79 227.9116 2.012196 $458.60 5.11
2011 $1,000 $94.28 243.6254 2.132928 $519.64 5.51
2-Jul-12 $99.00
249.13 Shares 2012 Value $24,663.69
Click to enlarge

While this is much closer to our $25,000 mark set by Coca-Cola, we see that a company that is able to increase its price by 5% a year, start out with a higher dividend yield and grow that dividend by 6% a year, still loses to an investment in a company with a "stagnant" share price. The underlying reasoning is the same, one is able to buy the shares of KO for a cheaper price in the middle years and the dividend grew by 15% a year over the period. It is enlightening to find out that the best possible thing, mathematically, to happen in the short-term for a wonderful company is for the share price to go down.

The lasting implications are two-fold. First, whenever there is a possibility of question, do the applicable math. Second, don't allow yourself to be pulled into the "the share price has been stagnant for the last decade, so it wasn't a good investment" ideology. There is a lesson to be learned here. As long as you own a collection of wonderful dividend companies, that continue to raise their payouts by a rate that far outpaces inflation, then the price can remain "stagnant" for decades and it would still turn out to be a worthwhile investment. More than that, a declining stock price without long-term impairment is precisely what one should be "rooting" for. There's comfort in the fact that the stock price of a wonderful dividend company doesn't have to do anything, and in fact it would be better if it decreased for it to be a successful investment.

Disclosure: I am long KO.