Sharing a Coke With Warren Buffett

Warren Buffett has always maintained that he looks for wonderful companies at fair prices. It's no surprise, then, that one of his longest-standing investments is in Coca-Cola (NYSE: KO  ) . In fact, he likes the company so much that Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) owns 200 million Coca-Cola shares, or 8.6% of the company. But what makes Coca-Cola such a great company? And is it really trading for a fair price?

Part I: Great Company
I want you to close your eyes and picture yourself relaxing on the beach with an ice cold Coca-Cola in your hand. How does that image make you feel? Now picture yourself holding a Pepsi or Dr Pepper, made by PepsiCo (NYSE: PEP  ) and Dr Pepper Snapple Group (NYSE: DPS  ) , respectively. Which one did you feel more at peace with? Which thought evoked more happiness?

For the majority of us, including myself, the image of holding a Coke was the most powerful of the three. In fact, for as long as I can remember, Coca-Cola has been synonymous with summer cookouts, vacations, and the beach.

But why?
Coca-Cola has built itself up to be one of the most recognizable brands in the world. Through relentless and pervasive advertising, the mere mention of the word "Coke" makes consumers all over the world begin to salivate. Try getting that kind of reaction from a Pepsi, Dr Pepper, or any number of Jones Soda (Nasdaq: JSDA  ) pops. It just ain't gonna happen.

Buffett's reasoning
There are many reasons Buffett loves Coca-Cola. The two most important are:

  1. The simplicity of the business.
  2. The wide competitive moat.

The simpler the business is to run, the easier it is to understand how it makes money now, and how it will make money in the future. How can you possibly value a stock if you aren't sure how it makes money? You can't. The second reason -- the wide competitive moat -- is truly the most important. If someone were to give you a few billion dollars and ask you to compete with Coca-Cola, you'd find out quickly that it simply cannot be done. Just ask its competitors. Coca-Cola's brand has been built up over many decades and is firmly rooted around the globe. A start-up doesn't have a snowball's chance at disrupting that.

It's apparent to this Fool that Coca-Cola will continue to reign supreme over the beverage market for the foreseeable future. But that, in itself, doesn't make it a good investment. Remember, the key is to find wonderful companies at fair prices, and we haven't yet discussed whether Coca-Cola is selling at a fair price. But good things come to those who wait.

Part II: Fair Price
Once you've found a wonderful company that is easy to understand and that has a wide competitive moat, determining whether it is priced fairly is the last step. The price-to-earnings ratio is perhaps the most common valuation metric, and I tend to look at the trailing-12-month ratio (P/E ttm) as well as the forward P/E ratio. Coca-Cola currently sports a 21 P/E ttm and a forward P/E of slightly above 16. From a historical perspective, the stock is pretty cheap. In the past 10 years, the company has maintained a trailing average P/E ratio of around 35. That's significantly higher than today's P/E of 21.

On this basis, Coca-Cola stock is cheap. It's more than fairly valued. To top it off, you get a solid 2.7% dividend yield with your partial ownership in one of the most recognized businesses in the world. And how else are you going to share a Coke with Warren Buffett?

Coca-Cola and Berkshire are Motley Fool Inside Value recommendations. Jones Soda is a Motley Fool Rule Breakers selection. Berkshire is a Motley Fool Stock Advisor pick. The Fool owns shares of Berkshire. Try any Foolish newsletter service free for 30 days.

Fool contributor Ryan Freund is ranked No. 46 out of more than 105,000 individual and professional investors in the Motley Fool CAPS game. He does not own any shares in any of the companies listed. The Fool has a rock-solid disclosure policy.

Read/Post Comments (5) | Recommend This Article (12)

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  • Report this Comment On June 14, 2008, at 6:14 AM, boysmakegoodpets wrote:

    "I want you to close your eyes and picture yourself relaxing on the beach with an ice cold Coca-Cola in your hand. How does that image make you feel? Now picture yourself holding a Pepsi or Dr Pepper, made by PepsiCo (NYSE: PEP) and Dr Pepper Snapple Group (NYSE: DPS), respectively. Which one did you feel more at peace with? Which thought evoked more happiness?"

    The Pepsi. And the reason doesn't have anything to do with brand recognition: the reason - so simple and yet so fundamental - is that Pepsi tastes better. Coke has a metallic undertone, like somebody dropped just a bit of iron - or blood - into the can (or bottle, or fountain - that unpleasant taste is there regardless of the source). Pepsi, on the other hand, tastes like pure, sweet deliciousness - there are no odd nuances to the flavor that make you smack your lips and wonder what that *taste* is. That's why the Pepsi Challenge is the Pepsi Challenge and not the Coke Challenge: because in a blind taste test, Pepsi will usually win.

    PepsiCo and Coca-Cola are both very well-run companies, and yes, the name "Coke" is to cola as "Kleenex" is to facial tissue (which I think is primarily because "Coke" is a little quicker and easier to say)...but that doesn't change the fact that, all else being equal, most people will agree that Pepsi is the better product. And let's hope that having a better product is still worth *something*.

  • Report this Comment On June 14, 2008, at 9:34 AM, Talendear wrote:

    In a side by side taste comparison most people may indeed think that Pepsi is the better tasting cola. I have not ever taken the challenge because as far as I am concerned, Pepsi is just too sweet tasting to begin with. I couldn't tell you which tastes better side by side, but my guess is that I would prefer the Coca-Cola for that reason. It does make me wonder if the same cola is always presented first to the consumer during the challenge though. Honestly, I do have to say that I disagree that "most people will agree that Pepsi is the better product" since it comes down to a matter of taste as well as advertising in much the same way as different people prefer different spices, flavours, and hotness to their foods.

  • Report this Comment On June 16, 2008, at 2:48 AM, none0such wrote:

    When Coke tried to respond to the Pepsi Challenge by marketing New Coke (I think these two events were consecutive so I would say changing your fundamental and timeless product is a response to something), some people lost their minds at the prospect of not having an authentic Coke - lets be real for a moment, this is a soda. The cultural aspects to Coke it what we all know and believe- from why Santa Claus wears red and has a white beard to the commercials we recall fondly and look forward to seeing during the Super Bowl. This is what you buy in a brand name. Maybe since I don't drink soda I couldn't care less on the finer points of another cultural element to Coke/Pepsi - elementary school fighting on which soda tastes the best.

  • Report this Comment On June 20, 2008, at 7:58 PM, solomon wrote:

    I agree that Pepsi probably does beat Coke in a blind taste test...but nobody shops blindfolded! And Coke is the most recognized brand in the world. That is tough to beat even if it does taste better.

  • Report this Comment On November 30, 2008, at 3:11 PM, RoyaleWihCheese wrote:

    none0such: New Coke was not a response to the Pepsi Challenge. New Coke was a planned disruption to the customers' palate so that they could replace the real sugar with high fructose corn syrup (HFCS). HFCS is easier to drink in mass quantities and cheaper, but does not taste the same. When they brought back "Real" Coke, it was with HFCS rather than cane sugar.

    Some Coke is still made with cane sugar; Costco will stock Mexican Coke at certain times of the year to cater to religious beliefs. Try it, glass bottled Coke with real sugar is quite different (and superior) to what we get now. It was a shrewd, and ultimately successful, move on KO's part to mask the disruption with New Coke. A shame that the product that followed was not as good as the product that preceded.

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