Cream Skimming and Bottom Feeding

by Rob Landley (TMF Oak)

AUSTIN, TX (August 25, 1999) -- I'd like to start today's column by repeating my previous pick of Cisco Systems (Nasdaq: CSCO) for this month's $500 investment. The insatiable demand for bandwith continues around the world and shows no signs of stopping before the average user in Botswana can download Gone with the Wind into her TV in two seconds.

The Internet is gradually replacing telephones, radio, television, newspapers, magazines, and postcards with a unified communications medium that can do it all and more. Cisco sells the little boxes that send all the data through the wires and make the Internet work. As long as the Internet keeps getting bigger and getting faster, Cisco has new customers to sell routers to and old customers needing to upgrade. This is the business that has made Cisco our best performing stock, even though we've held most of our other picks for several months longer. And most of the world has yet to connect to the Internet, while most of those who are online still connect via painfully slow modems.

However, rather than spending the rest of this column singing Cisco's praises, I'd like to walk down to the other end of the portfolio and talk about a stock we purchased in our first month, the current dog of the lot, The Coca Cola Company (NYSE: KO).

More than a year after we bought our chunk of Coca-Cola, the stock is trading down significantly and Coke's investor relations department seems burned out. After a half-dozen European health scares, Coke is now being sued for antitrust in Europe. Further, while Coke has been distracted in Europe, arch rival Pepsi has been aggressively marketing itself here in the States. Three years ago, Coke was recognized as the most admired company in Corporate America. These days, it's clearly on the defensive.

Yet it seems to me all of Coke's diverse domestic and international problems really boil down to a single cause: Coke is undergoing a management transition. On October 18, 1997, CEO Roberto Goizuetta died of lung cancer, and Douglas Ivester took over. Coke has been writhing in pain ever since, wracked on all sides by problems, and the frightening part is that this is COMPLETELY NORMAL.

Breaking in new management is often traumatic. Goizuetta was the man responsible for growing The Coca Cola Company from a $4.3 billion market cap in 1981 to $147 billion at the time of his death -- a 3400% increase in 17 years. And yet this was the man who started his tenure as CEO by forcing "New Coke" upon the world, actually believing that it would be a success because it won in blind taste tests separated from Coke's strongest asset, its brand name. This act literally resulted in marches and bomb threats because Goizuetta simply didn't understand what he was doing. Douglas Ivester's European trial by fire is fairly tame in comparison, and he seems quite capable of filling his predecessor's shoes once he gets up to speed.

But in the mean time, Coke is in pain, and this condition could easily continue for a year or more. The stock's ten-year outlook hasn't really changed, but its one- or two-year prognosis is dismal. As a result, the stock price is declining. Coke is becoming cheap.

When discussing Coke, talk eventually turns to superinvestor Warren Buffett, Chairman and CEO of Berkshire Hathaway, who bought a huge number of Coke shares a few years after "New Coke." He got in at reasonable price -- something darn hard to do with a Rule Maker -- by buying into the company when nobody else wanted to. Bargain Hunters who look to buy into great companies at low prices look for exactly the kind of circumstances that Warren Buffett found with Coke.

If Buffett bought into Coke cheaply after Goizuetta's early missteps, couldn't Ivester's European headaches lead to a similar buying opportunity with Coke? China and Russia remain largely untapped markets, the Minute Maid juice brand has yet to be stretched to its full potential, and Coke could easily expand into powdered drinks (possibly even using its huge profits to acquire existing brand names like Kool-Aid or Tang). Everybody on the planet drinks several beverages every day, it's one of the largest and most stable markets in the world.

Despite Coke's troubles and the endless speculation about market saturation, when Berkshire Hathaway's management was asked about the outlook for Coke this spring, Buffett and his second in command Charlie Munger responded "We think Coke is fine." I tend to agree.

In spite of that, I'm still recommending Cisco this time around for our monthly Rule Maker purchase. Valuation is nice, but it doesn't spur me to immediate action about a stock. I'm fundamentally pretty lazy about this sort of thing. Berkshire Hathaway's Coke shares were bought after the company had started to recover from Goizuetta's teething troubles, and I can wait until the actual problems settle down a bit. There's no rush here, really.

Of course, I'll still send my monthly check in to Coke's DRIP for my own portfolio. :)

Related Links:

- May 25, 1998 Fortune article on Doug Ivester
- Excerpt from Roberto Goizueta's biography I'd Like To Buy The World A Coke
- The Drip Porfolio's recently discussed Coke vs. Pepsi: Part 1, 2, 3
- A more recent Fool special on Buffett

- Oak

P.S. As you can see, we have a slick new format for presenting our portfolio numbers. That's all thanks to the hard and ingenious work of Fool techie David "Dagwood" Gardner. Some of the notation deserves some explanation. The "S&P 500 (DCA)" is a dollar-cost-averaged version of the S&P that assumes an investment in the S&P 500 on the same date and in the same dollar amount as each Rule Maker trade. This gives an apples-to-apples comparison to the Rule Maker's performance. The "S&P 500 (DA)" is the dividend adjusted (or, dividend reinvested) version of the S&P's returns. Much thanks to Dagwood for a job well done!