Why I'm Buying This Warren Buffett Favorite: Coca-Cola

"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
-- Warren Buffett

This is exactly the thinking that's guiding today's addition to the Real-Money Stock Picks portfolio I manage for the Fool. My portfolio is based on what I call "defensive value investing" -- buying and holding companies that have limited downside and attractive long-term fundamentals -- and today's subject is the epitome of such a stock: American icon Cola-Cola (NYSE: KO  ) .

Coke's turned the business of selling colored sugar water into one of the most powerful wealth-creating companies in American history. Its shares are up nearly 5,000% since 1978, and Coke's powerful compounding machine should keep generating market-beating returns for patient investors for years to come.

Cashing in on Coke
So how does Coke make such incredible profits from such a seemingly simple business?

Although bottling and distributing its wide range of products is capital intensive, Coke has managed to sidestep these costly endeavors by establishing partnerships with a network of 250 bottling partners in countries around the world. This tidy arrangement allows Coke to enjoy the high-margin business of simply selling its various syrups and concentrates to its bottling partners. Coke just sits back and watches the money roll in.

Its massive, global distribution network also enables Coke to bring unparalleled distribution to other brands it develops or acquires, creating a powerful barrier to entry against potential competitors. No one can match Coke's global distribution. It's no accident that Coke boasts an astounding 16 different beverage brands that generate more than $1 billion dollars in annual sales, which in total serve up 1.8 billion servings daily.

And all those servings add up to big-time profits that roll in with a consistency that would put most companies to shame. Since 1990, Coke hasn't seen its profit margins fall below 12%. During this same time frame, Coke's return on equity only dipped below 25% once. It's the "capital light" economics of selling syrup to its bottling partners that allow Coke to mint money year in and year out. 

Coke has gained a reputation for using its big-time profits to reward shareholders handsomely. The company has raised its dividend for 50 straight years, and shows no signs of slowing down. The same holds true in terms of share buybacks. Coke has reduced its overall share count by 6% since 2004, another trend that should only continue as the years roll on. 

Short-term problems, long-term profits
The market has driven Coke's share down more than 10% since May, which is what created this great buying opportunity altogether.

The problem?

Emerging markets, which should still act as a long-term growth driver for Coke, have thrown some short-term headwinds its way lately. In its earnings release today, for example, Coke revealed that its reported net revenue shrank 3% in the third quarter but actually grew 4% after adjusting for foreign exchange fluctuations. Foreign exchange headwinds had an even more powerful effect further down the income statement, where Coke's operating income declined 12%. However, factoring in the same currency adjustment, operating income actually grew 8% during the third quarter. 

Coca-Cola's struggles with a tumultuous foreign exchange market are obviously a key storyline affecting Coke and its stock. However, the silver lining here is that this is a headwind that's short-term in nature. Eventually Coke's currency woes will subside, and it will continue to benefit from the long-term growth trends that emerging markets truly present.

Foolish bottom line
My "defensive value investing" portfolio is all about finding companies that can thrive for years and even decades. With Coke's shares now yielding around 3% and trading at a very reasonable 20 times earnings, I'm perfectly content to pick up some shares at relatively depressed levels of this amazing business while the market's willing to do this Fool the favor.

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9/29/2016 11:32 AM
KO $42.26 Up +0.11 +0.25%
Coca-Cola CAPS Rating: ****