Drip Portfolio Report
Friday, September 5, 1997
by Randy Befumo (TMF Templr)

ALEXANDRIA, VA (Sept. 5, 1997) -- Coke Ain't It?

Many message board participants have been wondering why COCA-COLA (NYSE: KO), covered initially by co-writer Jeff Fischer, was not the Drip Portfolio's first purchase. Today I will try to explain why we decided to hold off on a Coca-Cola purchase decision.

Many investors operate under the somewhat naive assumption that they need only purchase a "great" company to reap substantial rewards. While certainly many great consumer brands have earned investors incredible returns, particularly over the past decade, what has always worked is never any guarantee that it will continue to work.

It was only 1986 when PEPSICO (NYSE: PEP) was bid up to absurd levels as it was widely viewed as having definitely "won" the cola wars. The view was so pronounced that there was a book written by PepsiCo Chief Executive Roger Enrico and writer Jesse Kornbluth with just that title -- How Pepsi Won the Cola Wars! The combination of the Pepsi Challenge, the miserable launch of New Coke, and the company's increasing market share were taken as powerful signs that PepsiCo had the winning business model.

Although it is difficult to convey today, the consensus that PepsiCo was the leading beverage company with the most focused operating model was absolutely agreed upon. More than almost any other consumer-oriented company at the time, PepsiCo was viewed as the company to own. Every form of investor, whether the smallest individual or the largest institution, knew that PepsiCo was the must-buy name. Although it is hard to believe, the Enrico-Kornbluth book was greeted with widespread enthusiasm, not the deep skepticism you feel when reading the title today.

In May 1986, PepsiCo hit what would be its high watermark of a split-adjusted $5.89 on all of the excitement. It would not be until mid-1989, three years later, that PepsiCo would climb above the $5.89 mark for more than a few weeks. By early 1995, the company traded at $20 and change, making for a 15.1% annualized return over that entire period had you bought all your shares in May of 1986. 15.1%, even at the high, is not bad, right?

Had you been dividend reinvesting in the company, things would have been about the same. If you had invested $100 a month in PepsiCo from May 1986 to May 1995, you would have owned 1,116.9 shares of PepsiCo valued at $23,236. However, over that time you would have put in $10,900. Using a pretty complicated process called an "internal rate of return," you can value each of those invested dollars in a way that accounts for the different time periods each represents and come up with the average annual return for this investment. This is roughly 14.4%.

Now, these 15%-ish numbers may seem fine, but if you had been a contrarian and bought the down and out Coca-Cola, things would have been quite a bit better. Your returns would have improved about 7% on an annualized basis and 9% on an internal return basis, meaning that you would have ended up with a whole lot more money at the end. Like twice as much, even though the difference on an annualized basis is only 7%. This was premised on the notion that you had the intellectual fortitude to start buying a company that everyone viewed as a loser, not the one everyone viewed as a winner.

Although one can say I did pick the time period pretty precisely, my point is that investing with the crowd, focusing on the businesses that everyone loves to death today, is not always the best way to make money. Ironically, the fact that the number of people reading the Drip Portfolio report dropped off every time I wrote about Owens Corning makes me wonder whether people are actually looking for new ideas or simply want confirmation of their pre-existing assumptions by some outside source. While certainly you would have done okay in PepsiCo following the crowd, you would have done a heck of a lot better in Coca-Cola on your own, avoiding the crowd.

Big investing wins come not only from sustained big growth, but from buying assets at low valuations and seeing those valuations increase over time. Even with a P/E in the mid 30s it would take Coca-Cola years at its current rate of EPS growth to get to a point where its valuation is even close to similar, large consumer oriented companies. Given my confidence that the operating earnings growth at Coca-Cola has decreased over the past few months for the reasons I will detail the next time I write, buying at today's valuation, even with a 20-year time horizon, might not make that much sense compared to other equally compelling companies -- or even a few companies that could result in incredible home runs.

--Randy Befumo