Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Coca Cola's Valuation For Warren Buffett's 1988 Purchase

|About: The Coca-Cola Company (KO)

For years, I, like many value investors, have wondered how Warren Buffett valued Coca Cola (NYSE:KO) stock at such a deep bargain in 1988.

This write-up is my basic estimation of the value of Coca Cola's Intrinsic Value Per Share in 1988.

First, I describe my 2-stage "discounted cash flow" valuation model. My estimating model is strict. It assumes a business will only "live" for 15 years. Within the model, I apply compounding growth to the first 10 years. Then, I take the cash flow from the 10th year and assume that there is no additional growth for years 11 thru year 15.

This restriction of zero growth in years 11 thru 15 mean that those yearly free cash flows are identical to the number obtained in year ten. And, this restriction imposes a degree of conservatism to optimism during the compounding growth years.

After we sum up all the individual end of year cash, we should apply a discount rate and bring that sum back to present value. At this point, we divide by the number of shares outstanding.

First, keep in mind, Warren Buffett said: "Intrinsic value as the discounted value of the cash that can be taken out of a business during its remaining life. Anyone calculating intrinsic value necessarily comes up with a highly subjective figure. This figure will change both as estimates of future cash flows are revised and as interest rates move. Despite its fuzziness, however, intrinsic value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses."

Again, I emphasize that my model is an "estimation method" that imposes conservatism by limiting the duration to 15 years and no growth in the final five years.

In 1988, KO stock traded between $35 and $45.25 and the preceding years' free cash flows were growing around the annual average of 21%.

After I found a copy of their old financial statements on the web, I started with a base estimate of annual Free Cash Flow at a value of approximately $1,096,883,333. This is the 3-yr average for 1986, 1987, 1988.

Their number of shares outstanding in 1988 was 364,612,000 shares. I used a discount rate of 8.65% because Treasuries had that 8.65% yield in 1988.

I used an assumed FCF annual growth of 20 percent for the first 10 years and assume zero growth from years 11 to 15.

The resulting estimated intrinsic value per share (after discounting the sum back to the present) is approximately $85.99.

Assuming that Warren Buffett bought at a Market Price of $45, and our resulting estimated Intrinsic Value is $85.99, his estimated bargain Warren Buffett obtained was estimated at 48 percent.

Alternatively, if I had used an assumed FCF annual growth of 15 percent for the first 10 years and assume zero growth from years 11 to 15. The resulting estimated intrinsic value per share (discounted back to the present) is approximately $62.5. At the Market Price of $40, the estimated Intrinsic Value is $62.5 and the estimated bargain would have been 36 percent.

Either way, keep in mind that Buffett bought an understandable business with sustainable competitive advantages, able trustworthy managers, and a significant bargain relative to its intrinsic value.

Bud Labitan

Disclosure: I am long KO, BRK.A. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.