As the stock market sits near all-time highs in the midst of a bull market going on five years -- and volatility is starting to spook some market participants -- many small investors do not know what to do. The solution? Just ask Warren Buffett.
Buffett owns Costco Wholesale (NASDAQ:COST) and Coca-Cola (NYSE:KO) because they offer safety of principal and the promise of a satisfactory return. Nobody can predict where the market or the economy will be one or two years from now, but the long run is easier to predict. Buying and holding great companies that have durable competitive advantages will always be a winning strategy in the long run. Investors who follow Buffett's lead and buy Costco and Coca-Cola are bound to end up with satisfactory returns over the long haul. Here's why these stocks look so good for the long term.
Costco cuts costs
Although Buffett has the final say on investment decisions, Charlie Munger was probably the impetus behind Berkshire Hathaway's (NYSE: BRK-A)(NYSE: BRK-B) Costco investment. Munger, who serves on Costco's board of directors, is an ardent advocate for the club-store chain, declaring that "Costco does more for civilization than the Rockefeller Foundation."
However, Costco has not been performing as well as expected lately. The stock is down nearly 6% year to date, as disappointing second-quarter results sparked a sell-off. Comparable-store sales increased only 4% last quarter, down from 7% in the same quarter a year ago. The quarterly profit also fell 15%, a lousy result.
Fortunately, Costco's long-term prospects are still promising. The company's operating efficiency and low cost structure give it an advantage over even its largest rivals. Instead of offering everything under the sun, like Wal-Mart Stores, Costco focuses on a narrow set of fast-selling products, allowing it to minimize its inventory. It does not advertise and does not dress up its stores with superficial decorations to appeal to customers, saving tens of millions in annual expenditures.
Costco makes its money through partnership fees and basically sells its merchandise at cost. About three-quarters of Costco's $3 billion in operating income comes from membership dues, with the balance coming from merchandise. Since members pay to join, Costco can offer deep discounts on hot items, giving the appearance of an outrageous deal.
Moreover, Costco has also shown a degree of pricing power in its membership fees. In November 2011, the company increased membership prices by 10%. Despite the price increase, member retention levels remained at historical levels near 90%. Although Costco may not get away with raising membership fees too often -- the 2011 price hike was the first since 2006 -- members' seeming apathy toward the 2011 price hike suggests that Costco has some pricing power. In any case, that Costco could raise prices by 10% without losing any customers should help shareholders sleep well at night.
Coca-Cola primed for gains
Many investors wonder why Coca-Cola is Buffett's second-largest holding. After all, it has averaged a measly 2.5% annual return since June 1998 -- including dividends! Moreover, the entire U.S. soft-drink industry seems to have fallen into a bottomless pit, with diet soda volumes in a free fall. As a result of weak U.S. demand for its diet soft drinks, Coca-Cola posted a mere 2% increase in beverage volume in 2013, about half of its long-term target.
Investors who only focus on U.S. headlines could easily put Coca-Cola in the throwaway pile. However, the company maintains a robust global offering. Its leading brand portfolio includes ubiquitous names such as Sprite, Dasani, Powerade, and Minute Maid. In 2012, the world consumed 658 billion 8-fluid-ounce servings of Coca-Cola beverages. Clearly, more than a few people still love Coke.
More important, the world is only going to consume more of Coca-Cola's beverages in the future. Despite health concerns about Coca-Cola's chief product, soda, U.S. consumption of all Coca-Cola beverages declined less than 6% in the 10-year period ending in 2012. While U.S. soda consumption has declined 12% since 2003, consumers are drinking more bottled water, juices, and teas -- all of which Coca-Cola is able to supply. At the same time, worldwide consumption of Coca-Cola's beverages increased more than 30%. This is the clearest reason to buy and hold Coca-Cola at 18.5 times consensus 2014 earnings estimates; as more people drink more Coke products, earnings per share are bound to continue an upward march.
Nobody knows what will happen in the stock market this year. One can only guess whether a year from now the market will be up, down, or right where it is today. However, Costco and Coca-Cola will almost certainly substantially increase in value over the next decade. That makes these Buffett-approved companies safe long-term investments for nervous investors.