As Berkshire Hathaway hosted its annual shareholders meeting the other week, this seems like a fitting time to review one of Berkshire Chairman and Chief Executive Officer Warren Buffett's favorite companies, Coca-Cola (KO +0.48%).
Warren Buffett is known as one of the world's greatest investors yet his investment style reverses the strategies of most other Wall Street icons. Instead of buying the hot stock of the month, Buffett is known for buying companies or pieces of companies that have durable competitive advantages, as well as companies he can understand that the market may not currently favor.
What are some of the factors that may have driven Buffett to acquire a large stake in Coca-Cola, and where can this company go from here?
Competitive advantages
A competitive advantage is anything from size, to brand power, to barriers of entry, among many other factors. A durable competitive advantage is any of those things that will withstand the test of time. These are what we look for in companies we want to buy.
Coca-Cola's brand name alone is most likely worth more than many publicly traded companies. Forbes has estimated the value of the brand at over $50 billion, ranking it the third-most-valuable brand in the world. From a consumer perspective branding is huge, as the company has succeeded in making consumers think of Coca-Cola when they think of soda.
When you're out at a restaurant you don't order by saying "can I have a soda, please?" You will typically say "Coke, please?" or "Sprite, please?" (Coca-Cola owns the Sprite brand) This is the company's brand power at work.
Coca-Cola's brand name is so strong that it does not have to engage in price wars with store-brand colas and other small drink makers to make consumers purchase its products, which does wonders for its margins.
Next is Coca-Cola's size. At one point around 100 years ago the company just sold one product with a secret recipe. Now, along with its namesake drink which uses the same secret recipe, Coca-Cola offers bottled water, flavored soft drinks, sports drinks, and more with over 100 worldwide brands.
If you're out at a restaurant or stopping by a drink machine anywhere in the world there's about a 50/50 chance you're going to be purchasing a Coca-Cola product, with the other 50% chance involving a sale for the company's largest competitor, PepsiCo. Though PepsiCo and Coca-Cola are stiff rivals and competitors, 50/50 odds are extremely good in comparison with most other highly competitive industries out there.
What these advantages have done for Coca-Cola
Coca-Cola's durable competitive advantages have been very good for the company and its shareholders over the years. Some of the key measures Coca-Cola excels on because of its advantages are growth and profitability measures.
Starting with growth, even as a large company in what most would consider a mature industry, Coca-Cola has grown its revenues and earnings by an average of 7.9% and 5.9% per year, respectively, over the last ten years.
As I mentioned margins earlier, Coca-Cola's margins benefit from the company's competitive advantages. Over the last ten years, the company has had stable and extremely high net profit margins that have averaged over 21%. Other profitability ratios are very strong as well. Over the same time-frame we can take a look at return on assets and return on equity to see that they averaged nearly 15% and 30%, respectively.
Stable and reliable numbers are great for companies that we may want to invest in. Though 5.9% earnings growth may not be that high, if it is something we can count on to happen each and every year, valuing this company is relatively simple and we can find opportunities to buy the company at very attractive prices.
Fool's bottom line
At The Motley Fool our goal is to help the world invest better, and taking the time to study great investors like Warren Buffett and the rationale behind his investments can really go a long way towards achieving that.
Coca-Cola has competitive advantages that have withstood the test of time, and they appear to have the durability to continue. Currently selling at almost 22 times earnings, Coca-Cola is a bit more expensive than the market, which sells at 18 times. I think the premium to the market is well deserved in this case, as Coca-Cola has shown that it is an excellent business for stockholders and I believe it will stay that way for the foreseeable future as well.
