ALEXANDRIA, VA (Aug. 6, 1999) -- It's my turn to share some thoughts on our first food and beverage study candidate, Coca-Cola (NYSE: KO). Jeff has done a superb job over the past two days of examining the issue of future growth prospects, which is one of our top concerns when looking at the company. Another major concern is Coke's golden market valuation, which has been incredibly resilient amidst the growth slowdown of the past few years.
Let's begin with a quote from Jeff from this portfolio's initial food and beverage study, which sums up Coke's recent performance quite nicely, I think.
"At this price, if Coca-Cola's earnings growth slows below the 18% expected, we could see very little stock appreciation over several years." -- Oct. 30, 1997
Talk about hitting the nail squarely on the head! Over the past few years, this is exactly the scenario that has unfolded. What's amazing, however, is how little Coke's valuation picture has changed over the same period.
Back in the fall of 1997, Coke changed hands for $56 per share and sported a trailing P/E of 34 and a price-to-sales ratio (PSR) of 8.2. As of yesterday's close, Coke trades at $60 7/8 per share with a trailing P/E of 43 and a PSR of 8.1, even though the expected growth rate has been ratcheted down to 14% from 18%.
Rather than chalking up Coke's valuation consistency to "overly optimistic investors" and dismissing it with a quick flick of the wrist like so many commentators are apt to do these days, let's remember exactly what kind of business we're talking about here. In terms of return on invested capital, margins, operating efficiency, and brand ubiquity, Coke blows away probably 99% of the businesses in the world. It has generated a tremendous amount of shareholder value for long-term investors in the past, including the recent past. Shouldn't that be worth something?
When discussing the company, most die-hard Coke investors will focus on the firm's stellar investment return track record. You know, the "If your parents had invested $1 in this company when you were born, it would be worth a gazillion dollars today" argument. We're more interested in the future than the past, but I think understanding the past is an important key to unlocking the mystery of Coke's persistently high valuation.
Let's take a look at Coke's past performance, for old time's sake.
Annual Percentage Change, with Dividends Reinvested
Coke(%) S&P 500(%) Difference(% pts)
1981 11.2% -4.8% +16.0
1982 60.1% 20.4% +39.7
1983 8.4% 22.4% -14.0
1984 22.2% 5.9% +16.3
1985 41.2% 31.0% +10.2
1986 37.9% 18.5% +19.4
1987 3.6% 5.7% -2.1
1988 20.6% 16.3% +4.3
1989 77.3% 31.3% +44.0
1990 22.6% -3.1% +25.7
1991 75.4% 30.0% +45.4
1992 5.7% 7.4% -1.7
1993 8.9% 9.9% -1.0
1994 16.8% 1.3% +15.5
1995 46.3% 37.2% +9.1
1996 42.8% 22.5% +20.3
1997 27.9% 33.1% -5.2
1998 1.3% 28.3% -27.0
Average
return: 29.5% 17.4% +12.1
Cpd
annual
:rtn 27.1% 16.7% +10.4
1999
(ytd) -8.7% 7.7% -16.4
Excluding the numbers for the first seven months of this year, Coke has lost to the market in 6 of the last 18 years, or 33% of the time. That may seem like a surprisingly high number, but focusing your attention on single-year periods is the wrong way to view things. During the years when it has beaten the market, Coke has flat-out spanked it by an average of 22.2 percentage points. And when it has lost out to the market's return, it has come up short by only an average of 8.5 percentage points.
This consistency and record for not just outperformance, but out-and-out outperformance, is worth something to investors. People pay up to go to a world-class university such as Harvard because of what a degree from that school has done for students in the past. Likewise, investors are willing to pay up for a wolrd-class company such as Coke because of what an investment in the firm has done for shareholders in the past.
Thanks to a disturbingly short-term "What have you done for me lately?" attitude, however, many Wise commentators are not willing to look at the big picture for this company. That Coke has underperformed the market during the past 24 months is not that big of a deal in and of itself, especially considering how it has outperformed during the previous 216 months on the a whole.
What has people worried, I think, is how badly Coke underperformed the market last year and how badly it is underperforming again this year. Is this the beginning of the end of the company's outstanding run over the past few decades? Who knows for sure, but I'm willing to side with investors who believe these past two years have been hiccups and not signs of a more serious malignancy.
Coke's intrinsic quality remains world-class, quite possibly better than any other publicly traded company out there. Two years of sub-par performance does not change that fact. It deserves a higher valuation than your average S&P 500 company. But that doesn't necessarily mean that it deserves our investment money.
Remember, we care about two crucial things when it comes to purchasing stocks -- quality and price. In the grand scheme of things, it may be hard to pay too much for a business with exceptional quality, but we are not willing to totally discount price right out of the equation. We'll freely admit that we're greedy and that we want the best of both worlds.
Since we began with a quote, let's end with one as well. This one also comes from the portfolio's initial food and beverage study and was penned by former manager Randy Befumo.
"Big investing wins come not only from sustained big growth, but from buying assets at low valuations and seeing those valuations increase over time."
Right now, Coke is falling short on both counts. We're just beginning our analysis, of course, and Jeff is planning to spend more time discussing Coke early next week before we move onto our second study candidate, PepsiCo (NYSE: PEP).
Until then, have a great weekend!
