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The Warren Buffett Way

Buffett's Investments: The Coca-Cola Company

The Coca-Cola investment is very close to Buffet's heart. He made the investment at 5x book value and 15x earnings, which was above the average market valuation during that time. Buffett had spent about $1.02 billion to acquire a 7% stake in the company, which was the largest investment ever made by Warren Buffett.

 

Simple and understandable business

Coca-Cola is the simplest business to own. The company manufactures bottled soda and distributes it throughout the world. The company sees itself as distributing happiness and has immense admiration throughout the world for its products. The company also  provides soft drink syrups to quick service restaurants and movie halls that in turn sell them to their customers at a higher price.

 

Consistent operating history

The company started in the year 1886. 137 years later, the company is still selling the same product + numerous other products. There has been significant growth in the company’s size and geographic reach during the period. 50 years after its inception, the company was selling 207 million cases of soft drinks “annually” while today it is selling 1.7 billion cases “daily”. Nothing matches the distribution and consistency of Coca-Cola.

 

Favorable long-term prospects

Although Buffett knew about Coca-Cola since his childhood, however, he purchased it in the 1980s because of the favorable changes that were happening in the company under the leadership of Roberto Goizueta (Chairman and CEO) and Donald Keough (President).

 

The 1970s was a difficult time for Coca-Cola. They were: 

  1. Dispute among distributors
  2. Federal Trade Commission charged the company with violation of the Sherman Antitrust Act (prohibits activities that restrict interstate commerce and competition in the marketplace)
  3. International business in Arab, Israel and Japan is slowing down.
  4. Quality issues in the Japanese market
  5. Unrelated diversification
  6. Low employee morale

Then came Roberto Goizueta. He encouraged teamwork and one of the first tasks was to bring all 50 managers together and ask them “what was being done wrong in the company”. In this meeting the company constructed a 900-pager pamphlet called “Strategy for 1980s' ' outlining the corporate goals for Coca-Cola.
He began cutting costs and optimizing return on assets. This translated into higher profit margins for the company.

 

High profit margins

In 1980, the company earned a pre-tax margin of 12.9%. In Goizueta’s first year it grew to 13.7% due to his cost optimization measures and finally in 1988 when Buffett purchased his shares, the pre-tax margins stood at 19%.

 

Return on equity

As a major step of his strategy, Goizueta divested any business that was not generating an acceptable ROE. Also, any new business that the company would enter should have the potential to generate real growth. Growth can be of two types, one that is based on intrinsic growth, i.e. through quantity (real growth) and the other which is based on price increases (inflation). One that is based on volume growth is more sustainable growth. By 1988, Coca-Cola had generated an ROE of 31%.

 

Rational management

While Coca-Cola increased the dividends per share, it also initiated a buyback program in order to increase the ROE of the company. ROE is basically, Net Profit divided by the Equity of a company. When a company buys back its shares, the equity of the company falls and hence the denominator (equity in this case) decreases. This leads to a higher ROE.

 

Institutional imperative

Goizueta was focused on increasing the ROE of the company. Divesting unviable yet exciting businesses like vineyards was a bold move. He took actions on time and was not concerned about the institutional ownership in the company and was concerned about the retail investors. It signifies his unwavering focus on business and ROE generation.

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