Warren Buffett has always maintained that he looks for wonderful companies at fair prices. It's no surprise, then, that one of his longest-standing investments is in Coca-Cola (NYSE:KO). In fact, he likes the company so much that Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) owns 200 million Coca-Cola shares, or 8.6% of the company. But what makes Coca-Cola such a great company? And is it really trading for a fair price?
Part I: Great Company
I want you to close your eyes and picture yourself relaxing on the beach with an ice cold Coca-Cola in your hand. How does that image make you feel? Now picture yourself holding a Pepsi or Dr Pepper, made by PepsiCo (NYSE:PEP) and Dr Pepper Snapple Group (NYSE:DPS), respectively. Which one did you feel more at peace with? Which thought evoked more happiness?
For the majority of us, including myself, the image of holding a Coke was the most powerful of the three. In fact, for as long as I can remember, Coca-Cola has been synonymous with summer cookouts, vacations, and the beach.
But why?
Coca-Cola has built itself up to be one of the most recognizable brands in the world. Through relentless and pervasive advertising, the mere mention of the word "Coke" makes consumers all over the world begin to salivate. Try getting that kind of reaction from a Pepsi, Dr Pepper, or any number of Jones Soda (NASDAQ:JSDA) pops. It just ain't gonna happen.
Buffett's reasoning
There are many reasons Buffett loves Coca-Cola. The two most important are:
- The simplicity of the business.
- The wide competitive moat.
The simpler the business is to run, the easier it is to understand how it makes money now, and how it will make money in the future. How can you possibly value a stock if you aren't sure how it makes money? You can't. The second reason -- the wide competitive moat -- is truly the most important. If someone were to give you a few billion dollars and ask you to compete with Coca-Cola, you'd find out quickly that it simply cannot be done. Just ask its competitors. Coca-Cola's brand has been built up over many decades and is firmly rooted around the globe. A start-up doesn't have a snowball's chance at disrupting that.
It's apparent to this Fool that Coca-Cola will continue to reign supreme over the beverage market for the foreseeable future. But that, in itself, doesn't make it a good investment. Remember, the key is to find wonderful companies at fair prices, and we haven't yet discussed whether Coca-Cola is selling at a fair price. But good things come to those who wait.
Part II: Fair Price
Once you've found a wonderful company that is easy to understand and that has a wide competitive moat, determining whether it is priced fairly is the last step. The price-to-earnings ratio is perhaps the most common valuation metric, and I tend to look at the trailing-12-month ratio (P/E ttm) as well as the forward P/E ratio. Coca-Cola currently sports a 21 P/E ttm and a forward P/E of slightly above 16. From a historical perspective, the stock is pretty cheap. In the past 10 years, the company has maintained a trailing average P/E ratio of around 35. That's significantly higher than today's P/E of 21.
On this basis, Coca-Cola stock is cheap. It's more than fairly valued. To top it off, you get a solid 2.7% dividend yield with your partial ownership in one of the most recognized businesses in the world. And how else are you going to share a Coke with Warren Buffett?
