Coke Stock: One of Warren Buffett's Biggest Investments Might Be His Worst

Global beverage titan Coca-Cola (NYSE: KO  ) has for a long time been one of Warren Buffett's largest holdings at Berkshire Hathaway (NYSE: BRK-B  ) . Buffett began purchasing Coke stock in 1988, and the stock saw tremendous gains for the next decade, leading some observers to call Coca-Cola one of his greatest investments. Yet the stock's performance since 1998 has been decidedly mediocre.

Coke stock has joined in the recent market rally, more than doubling off its Great Recession low. That said, I'm skeptical that the company will be able to grow its bottom line enough to justify its generous P/E ratio of 20.7. Coca-Cola may therefore continue its long run as one of the biggest dogs of Buffett's portfolio.

A love affair with Coke
Coca-Cola has been the largest holding in Berkshire Hathaway's equity portfolio for much of the past two decades. In the earliest 13F filing available online from the SEC -- for the first quarter of 1999 -- Berkshire Hathaway reported holding 200 million shares of Coke stock, valued at $61.375 a share, or more than $12 billion in total.

Buffett is often associated with the "buy and hold forever" investing strategy, and this is exactly what he has done with Coca-Cola. Berkshire Hathaway still owns every one of those shares -- although a recent stock split means that Berkshire now owns 400 million Coke shares, valued today at more than $16 billion. That makes it the second largest holding in Buffett's portfolio, only recently eclipsed by Wells Fargo.

Yet Coca-Cola has basically been a dud in Buffett's portfolio for the past 15 years. While the stock has recovered very nicely from the global recession in the past four years, it still sits below the all-time high it touched all the way back in mid-1998:

KO Chart

Coca-Cola 15-Year Price Chart (split-adjusted); data by YCharts.

Of course, the stock market as a whole hasn't performed too well for the past 15 years, either. There was a crash at the end of the bubble period in 2000, followed by a second crash associated with the 2008-2009 recession. Still, the S&P 500 has outperformed Coke stock by nearly 40% over the whole 15-year period:

KO Chart

Coca-Cola vs. the S&P 500; data by YCharts.

Poor total return
From a total return perspective -- which includes the benefit of dividends -- Coca-Cola has still been a poor investment since 1998. Since June 1998, Coke stock has generated a total return of 33%. Obviously, that's a lot better than losing money; however, it represents a less than 2% annualized return. Buffett could have done better in government bonds!

KO Total Return Price Chart

Coca-Cola Total Return (June 1998-present); data by YCharts.

In short, this means that Buffett and Berkshire Hathaway investors have had a lot of money tied up in an underperforming stock for a very long time. Coca-Cola was a great investment in the 1990s, but in retrospect, Buffett clearly should have sold when the shares spiked in 1998. Furthermore, I would argue that it should have been obvious at the time that Coke was overvalued. Based on Coca-Cola's EPS of $1.64 in 1997, the company was trading at 50 times earnings when it peaked in mid-1998. When that happened, Buffett should have ignored his "buy and hold forever" mantra in favor of his equally famous advice: "Be fearful when others are greedy."

Foolish conclusion
In 1998, Buffett looked like a genius for buying Coke stock when he did. In 10 years, Coca-Cola had returned more than 1,000%. That strong initial performance makes Coca-Cola look like a good performer in Buffett's portfolio when considering the full 25-year holding period to date. Yet the stock has been a dud for the past 15 years, drastically underperforming the S&P 500 and offering a total return of approximately 2% annually.

Looking forward, I don't think the next decade will be much better than the last one for Coca-Cola. Coke stock currently trades at 20 times earnings, which is fairly pricey considering that analysts are expecting earnings growth in the high single digits for the next few years. Sugary beverages are no longer a growth product. If anything, the rise in health consciousness (and anti-soda campaigns such as Michael Bloomberg's crusade in New York) will cause a slow decline in demand for Coca-Cola's products. Thus, Coke may continue to be an underperformer in Warren Buffett's portfolio for the foreseeable future.

Coca-Cola's wide moat has helped provide its shareholders with superior gains in the past, but the company faces some new threats to its continued market dominance. The Motley Fool recently compiled a premium research report containing everything you need to know about Coca-Cola. If you own or are considering owning shares in the company, you'll want to click here now and get started!


Read/Post Comments (23) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 14, 2013, at 11:41 AM, budlab wrote:

    Dear Warren,

    Scott Thompson and I are putting the finishing touches on a small booklet

    called "1988 Coca-Cola Valuation: estimated intrinsic value." And, while I

    am satisfied with our estimations, I have a nagging feeling that we did not

    fully explain the magic of your Coca-Cola purchase up to the present time.

    I like working with Scott Thompson because he always rechecks our math. In

    turn, trained as a biologist and family physician, I try to give him the big

    picture about the nature of the business in its competitive environment. So,

    we have fun talking about this stuff. However, since this section bothered

    me all night long. We did not fully explain the impact of your Coca-Cola

    purchase up to the present time. So, I decided to do the math myself.

    Did You and Berkshire Hathaway really receive close to 10.4 billion dollars

    in CocaCola dividends over the years or is my math wrong? I added up all the

    dividends per share since 1988 for a sum of $26.14. Then, I multiplied

    $26.14 times the 400,000,000 shares stated in the 2012 annual report; the

    result equals $10,456,000,000

    When I add this 10.4 billion to the 14.5 billion worth of shares you

    currently hold, I get a total return of about $24.956 billion.

    Amazingly, using rough math, this total return of $24.956 billion divided by

    the initial cost of 1.299 billion equals 19.21 or 1921%

    1921% divided by 25 years equals 76.8% "per year average return" !

    Could this be right? Or did I mess up my math in one of the steps above?

    Sincerely,

    Bud Labitan

  • Report this Comment On April 14, 2013, at 12:26 PM, valueinvesting12 wrote:

    Dear Bud,

    You need to adjust your count of the number of shares for each year, which have been split several times. Go to Bing and type in "coca-cola split history"

    Sincerely,

    Someone Who Is Not Warren Buffett But Is Answering For Him Because I Doubt He Reads Motley Fool Comments

  • Report this Comment On April 14, 2013, at 12:30 PM, valueinvesting12 wrote:

    Adam Levine-Weinberg,

    The Snowball talks about how Buffett was wanting to sell his Coca-Cola shares in the late nineties when it was 50x earnings, but he couldn't because 1) he was on the board and 2) he used Coca-Cola as his talking-point example of the best company in the world.

    Your article is an excellent demonstration of how price is such a crucial factor for an investor. A company can literally be the best in the world but if you pay too high a price, you could have a bad result for a long time.

  • Report this Comment On April 14, 2013, at 1:28 PM, rsinj wrote:

    What is funny reading through this article, is that last year, when SunTrust Bank was selling their hoard of KO stock which it acquired like 100 years ago, another Fool author had the nerve to post an article how STI was the absolute worst company to invest in specifically because they were selling their KO stake to raise about $1 billion to solidify their balance sheet. It made perfect sense to me at the time why they were selling the shares, and now this article just makes the point even more.

    I forget who that Fool author was, but I think you should contact him and have him read this article.

  • Report this Comment On April 14, 2013, at 1:42 PM, TMFGemHunter wrote:

    @rsinj: I wasn't aware of that other article. I can see if I can find it. Coca-Cola has actually done relatively well over the past year, mostly because the market has gone up. But I just can't imagine this stock beating the market over the next five or ten years. It's not that cheap, and it's not going to grow very quickly.

    @valueinvesting12: Thanks for the comment. It's really hard to find a lot of top-notch companies at good prices. A lot of my colleagues at Motley Fool like Amazon, for example. I just can't justify paying 2X revenue and 75X forward earnings (and I'm skeptical AMZN will even hit the 2014 earnings estimates), no matter how "great" Amazon may be.

    Adam

  • Report this Comment On April 14, 2013, at 1:53 PM, abierce121 wrote:

    "in retrospect, Buffett clearly should have sold when the shares spiked in 1998"

    Uh, yeah, but the hindsight observation that "selling the spikes" is a good idea is not really useful information.

  • Report this Comment On April 14, 2013, at 2:17 PM, TMFGemHunter wrote:

    @abierce121: I don't quite understand your point. It was clear at the time as well that the shares were spiking. The only question was whether they would continue to rise or not. As I stated immediately thereafter, based on Coca-Cola's relatively modest growth rate at the time and the 50X multiple, the odds were that Coca-Cola was set up to drop.

    If you had sold when the shares crossed the 40X multiple, you would have missed out on a bunch of potential profit. But that still would have been the right long-term decision, in my opinion.

  • Report this Comment On April 14, 2013, at 2:50 PM, margiecfl wrote:

    Did you take into account all the dividends paid when determining whether the stock beat government bonds?

  • Report this Comment On April 14, 2013, at 2:57 PM, LadyMantle wrote:

    I think we can all look back to 1998 which seemed to be a pivotal year in this country for "old paradigm versus the new." Many people made major changes to their lives and others stayed on the same old treadmill pretty much unware of the opportunities. If you had insider information, you could have riden the dot com rainbow to riches. Soft drinks have been declining in popularity due to claims of causing obesity and other health related problems. Tobacco also has taken a hit. Alcohol is not far behind. Sustainability is the word that we need to embrace. If what you invest in is not sustainable in terms of energy, health or has a proven reliable-safety index, it is not a good long-term or even short-term investment. Coca cola has been known to degrade bone and nails within hours of contact. It's more of a cleaning agent than a beverage.

  • Report this Comment On April 14, 2013, at 3:14 PM, ryanchandler25 wrote:

    I personally think this is one of the most idiotic articles. First, with the benefit of hindsight it's easy to write about what an investor should have or shouldn't have done. In practice it's usually a much different story.

    Second, KO is a stalwart. Everyone, including Buffett, knows that it isn;t going to double in a couple years.

    Third, a buy and hold requires a long term perspective. To sit back and say, "well the stock hasn't done anything in the last several years, so it's best to sell," demonstrates a lack of understanding about a buy and hold strategy. It's not what the stock has done over the past few years, it's what the underlying company will do 5, 10, or 20 years into the future that matters. Buffett calls it a durable competitive advantage.

    Fourth, unloading 200 million or 400 million shares is a lot more difficult than an indiviudal selling a couple hundred shares.

    Finally, this analysis fails to consider the dividend yield. You say that over the last 15 year the annual return was less than 2%. Well that doesn't include the dividend. You have to remember that Buffett bought at a very low price, so he initially got a very good yield, that has only increased over time as KO has increased thier dividend regularly. According to historical prices on yahoo, adjusted for splits, coke sold for less than $2/share around the time Buffett bought it. The current dividend is $1.12/share. That gives him a dividend yield of more than 50%.

    Yes if you're an investor looking to buy Coke right now, the valuation isn't attractive, but for anyone that bought the stock were Buffett did it's a no brainer to hold it for life.

  • Report this Comment On April 14, 2013, at 3:24 PM, TMFGemHunter wrote:

    @margiecfl and ryanchandler25: The 33% return is total return. In other words, that includes dividends. In fact, that's only dividends, because the stock itself is still slightly below the 1998 high.

    I don't disagree that it would have been hard for Buffett to sell everything in 1998. However, it wouldn't have been impossible to sell a large chunk relatively close to the high price in 1998 (although valueinvesting12 made a good point above).

    More broadly, the whole point of this article is that it's not a few years of underperformance. It's 15 years of below market returns with higher risk (owning a single stock is almost always more risky than owning the market). If, as I argued above, Coke is again overvalued today, then it's just as good a time as ever to sell.

    What's Coke's durable competitive advantage? It has a very recognizable brand name. However, that brand name is associated with sugary beverages, a category that the world is gradually turning against.

    Adam

  • Report this Comment On April 14, 2013, at 4:39 PM, ryanchandler25 wrote:

    Adam,

    What I'm saying is that from Buffett's perspective it's not underperforming because he is getting a dividend yield of over 50% based on the initial price he bought the shares and the dividend the company is paying today.

    This is the part I don't think you're understanding.

    Give me a dividend yield > 50% on a solid company and I don't care what the stock itself does. What, I should sell a stock that I'm getting a 50% yield on just because it's selling for over 20x earning and seems overvalued?

    For the ordinary investor who isn't banking what Warren is banking on this stock, yes obviously sell it if it seems overvalued. But that doesn't mean that it's overvalued from Buffett's perspective, nor does it mean it's one of his worst investments. In fact the dividend yield that he's getting makes it still one of his best investments ever.

    Also the time period you're referencing is somewhat flawed. I mean you're taking the price at the height of biggest bull market in history. If you buy stocks at the top of bull market, they frequently underperform. The price you pay determines your return.

  • Report this Comment On April 14, 2013, at 4:58 PM, TMFGemHunter wrote:

    Ryan: It's not a 50% dividend yield. It doesn't matter whether Buffett bought it for $2 or $20; all that matters now is whether it will perform better or worse than the market going forward. Coke is trading for around $41 a share today, and that's the opportunity cost to holding it. In fact, it's also on Berkshire's books at (approximately that cost), because Berkshire Hathaway frequently marks its investments' value to the market value. If I had $16 billion lying around, I could think of better places to put it than Coca-Cola. Just my opinion.

    To put it another way, the value of a stock to a non-shareholder is no different than the value to a shareholder. If it's overvalued for me, than it's also overvalued for Buffett (all else equal). All that "overvalued" means is that there are other investment opportunities offering a better risk-return tradeoff.

    You're correct that measuring from the top in 1998 makes the absolute return look bad. However, Coca-Cola is also underperforming the S&P 500 over that time period. So while mid-1998 may have been a bad time to buy stocks in general, it was a particularly bad time to buy (or hold) Coca-Cola.

    Adam

  • Report this Comment On April 14, 2013, at 5:19 PM, ryanchandler25 wrote:

    Adam, how can you say that his yield is not > 50%? He bought the stock for under $2 adjusted for all splits, and it currently pays a dividend of $1.12 per share.

    The price you pay certainly matters. It matters if he bought it at $2 or at $20 because his return is going to be a lot lower at the latter price.

    Of course, if you had $16 billion sitting around, you would foolish (no pun intended) to buy Coke at the current price. But if you used that $16 billion to buy it in 1987-1988, this year you would be making roughly $8 billion in dividend income off your initial investment.

    What's more, is that the return is increasing each and every year that Coke increases their dividend. People are always going to buy soda. Obviously, soda isn't a huge growth industry, which will likely result in a higher payout in years to come, thereby increasing Buffett's return even more. When they increase the dividend to $2/share, his return is going to be over 100% per year on the stock regardless of how the market values Coke.

    You're simply looking at it from the perspective of if it will underperform the market over the next few years. I'm looking at it from the perspective of making $8 billion annually from an initial investment of $16 billion. If I'm getting that kind of return, I don't care what the market does or if Coke apprieciates enough in price to beat the market.

  • Report this Comment On April 14, 2013, at 5:35 PM, TMFGemHunter wrote:

    Ryan: You're way of looking at it does not take into account the opportunity cost of holding onto the shares. Buffett has 400 million shares, so that means he's getting about $450 million in dividends each year. If he's after income, he could sell his Coke stock for $16.5 billion (approximately) and find a stock yielding 5% (there are plenty of those around). Then, he would be getting over $800 million of dividend income per year.

    The price you buy at impacts your total return; obviously, you want to buy low. But it's totally irrelevant to the decision about whether you should hold or sell now. You should only hold a stock if you think it will outperform other assets of similar risk-level over your time horizon.

    Adam

  • Report this Comment On April 14, 2013, at 6:34 PM, clintm15 wrote:

    I'm not sure what plants you people have been smoking but you have bewildered me.

    The cold hard fact is that Berkshire's total investment in Coca-Cola is around $1.3bn and it's current market value is $14.5bn.

    Warren doesn't have the luxury of being able to move capital quickly and freely so each investment must be judged in singularity. Berkshire's position in Coca-Cola has been unchanged for 15 years or so.

  • Report this Comment On April 14, 2013, at 8:28 PM, TMFGemHunter wrote:

    @clintm15: that's the whole point of my article. It's buy and hold forever at its purest. Obviously Warren Buffett isn't day-trading (and shouldn't be doing that either. However, my argument is that he could have and should have wound down the investment back in the late 90s when Coke was overvalued (or at least fairly valued).

    Instead Berkshire has had a sizable chunk of its equity portfolio tied up in a stock that has seen zero capital appreciation for fifteen years while throwing off a fairly modest dividend. Surely Buffett could have found a better spot to park $15-$16 billion in 1998.

  • Report this Comment On April 15, 2013, at 3:50 PM, Spw225 wrote:

    The price you pay determines your rate of return. There is no analysis of Buffett's cost of purchase or of the rising dividend over time. I read that Buffett's average purchase price was 6.50 per share. If so, and the current dividend payment is 1.12 per share, his return just on the dividend is 17.2% per year now, plus the stock has split several times. It looks like his current yield based on cost may actually be even higher. Seems unlikely he could put his KO investment elsewhere for a relatively safe return of over 15% on the dividend alone.

  • Report this Comment On April 15, 2013, at 5:05 PM, TMFGemHunter wrote:

    @Spw225: You are confusing two concepts. Yes, because Buffett paid so little for KO shares, he has earned a very high return on that investment. But today, the shares are worth $40 a piece ($41 last week). He's only earning a 2.7% yield on the value of the shares. If he sells and pockets $16 billion (currently yielding about $450 million a year), he can get a higher yield in any stock with a 3% dividend.

    Buffett isn't necessarily interested in maximizing his dividend yield; his investments are primarily about long-term capital appreciation. My point is that the price he paid back in 1988 has no effect on the decision today to hold or sell.

    Adam

  • Report this Comment On April 16, 2013, at 3:57 AM, ryanchandler25 wrote:

    ggg

  • Report this Comment On April 16, 2013, at 4:12 AM, ryanchandler25 wrote:

    Adam,

    Fact it, you're dead wrong on your analysis as pointed out by several posters.

    It amazes me how often novice investors sit back and criticize the most successful investor in the world. He shoulda did this. He coulda did that. He woulda made a bigger return. It's easy to play monday morning QB. It's a lot harder to make those calls when you're the one actually playing the game.

    He is still earning a high return on those shares, Adam, that's what you're not understanding. He making $450 million annually off of an initial investment of $1.3 billion. Investing the money in another company is problematic for many reasons, one being that very few companies have a durable competitive advatange like Coke.

    Instead of looking at Buffett's holdings trying to find something to criticize (like the thought never occurred to him to sell it at 50x earnings) you should look at this portfolio and try to learn something about investing.

  • Report this Comment On April 17, 2013, at 3:02 PM, TMFGemHunter wrote:

    Ryan,

    It's fine to argue that Coke has a durable competitive advantage, and that this makes it a better investment than the alternatives. But to say that Buffett should hold onto Coke simply because he bought at a good price is just plain wrong. All that matters today is whether Coke will beat the market in the future. If it will, Buffett should hold (and you and I should buy). If it won't beat the market then Buffett should sell (and we should avoid it).

    I agree that Buffett is one of the most successful investors in history. His record proves that beyond a doubt. But Coke was a stock that he should have dumped in the late 1990s after he had already made massive profits.

    Adam

  • Report this Comment On November 21, 2013, at 6:16 AM, JohnS wrote:

    Coca Cola is facing some major problems due to change in consumer preferences towards healthier alternatives in the developed countries. Sales volume in Europe experienced a 1% growth only and faced a 4% decline in North America per year over the past decade. http://goo.gl/CYaAp0

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