Warren Buffett is Coca-Cola's (KO 1.10%) biggest shareholder. Berkshire Hathaway owns 400 million shares of the soft drink giant, a stake worth nearly $16.2 billion. PepsiCo (PEP 1.51%) is nowhere to be found in the legendary investor's portfolio.
Buffett began accumulating shares of Coca-Cola in 1988 when the stock was trading between 14 and 15 times earnings -- hardly a price that screams "value!" But Buffett saw a company that was on the verge of massive shareholder creation -- even more than had occurred in the past.
Coca-Cola went on to become one of Buffett's greatest investments. Moreover, the conditions that made Coca-Cola a great investment in the late 1980s still exist today -- making it a potentially great investment for the current generation.
Two keys to Buffett's investment in Coca-Cola
In 1988, Coca-Cola had two key attributes that made it an appealing investment: pricing power and untapped growth. The pricing power should have been obvious to anyone. Brand loyalty enables Coca-Cola to raise prices without worrying about a sharp drop-off in sales volume.
For the most part, people who drink Coke only drink Coke; Coke drinkers will not drink a Pepsi just because it is a dime cheaper. The same is true for many of Coca-Cola's brands -- then and now. This is an invaluable trait that few companies have -- but that most of Buffett's investments have. Pricing power creates value for shareholders like no other.
Investors, then and now, could be forgiven for not seeing the second attribute that makes Coca-Cola a wonderful long-term investment. Let's see if you can spot it. Look at the chart below; look at the black bars (per capita Coke consumption in 1992) and then look at the green bars (per capita consumption in 2012). What would make Buffett think Coca-Cola had significant untapped growth?
Source: Coca-Cola
Here's my guess: Buffett saw that Coca-Cola was an exportable brand. It is something that all people in all countries can enjoy and the company has a massive distribution network that can deliver the product to all parts of the world.
In 1992, the United States had the highest per capita Coke consumption in the world. Two decades (and billions in profits for Buffett) later, Mexico, Chile, and Panama zoomed past the United States as people around the world embraced Coke.
I am not so sure that I would have seen Coca-Cola's opportunity in 1988, but I can see it now. Mexico, Chile, Panama, and the United States: these are not the most culturally similar places on the globe, yet the citizens of each country drink gobs of Coca-Cola's beverages each year. Other countries in the top 10 include Spain, Bolivia, and South Africa.
Coca-Cola truly is a global brand -- which is why its growth opportunity is as big today as it was in 1988. The top 10 Coke-consuming countries drink 386 servings of Coca-Cola beverages per person per year. By comparison, the worldwide average consumption rate is only 94 servings per person per year.
Source: The Coca Cola Company and author's calculations
There is no reason -- cultural or economic -- that the rest of the world should not one day drink as much Coke as the top 10 countries. As Coca-Cola expands its reach and exports its brand to all corners of the globe, the consumption gap between the top 10 countries and the rest of the world will narrow. Fortunately for long-term investors, the rest of the world will drink a lot more Coke before it catches up.
PepsiCo would have been a good investment too
If you compare the price history of Coca-Cola to that of PepsiCo, you will notice that it did not really matter whether Buffett purchased Coca-Cola or PepsiCo. Both businesses benefit from the ability to raise prices and export their brands around the globe.
Though PepsiCo may be a distant second in the cola wars, its wide moat Frito Lay division gives it something that Coca-Cola does not have: diversification. If past trends are any indication, far more carbonated soft drinks will be consumed in 20 years than are consumed today. But in the short run, declining soft drink consumption in the United States puts a lid on Coca-Cola's growth.
On the other hand, Frito Lay -- the largest salty snacks company in the world -- offers PepsiCo the same global dominance as Coca-Cola without the baggage tied to soft drinks.
Regardless, Coca-Cola and PepsiCo are poised for another two decades of incredible growth.
