In 1987/1988 Warren Buffett placed nearly 25% of Berkshire Hathaway’s net worth into Coca-Cola stock. Since then, value investors have wondered what Buffett saw in the stock and how he had the confidence to place such a large portion of his portfolio into one stock. I’ve been able to obtain several of Coke’s shareholder letters from the 1980’s and have been evaluating the numbers myself. The 1988 report in particular shows a company with a clear plan in place to take over the world. Back then Coca-Cola still had plenty of opportunity to benefit from a “Lollapalooza effect” of 1) increasing customer base, as Coke expanded into more world markets, and 2) increasing consumption by existing customers, as sodas became a greater part of the american and developed worlds’ diet.
The 1988 Letter is both a celebration of the turnaround success led by CEO Robert Goizueta, and a realization that billions of people at the time had yet to have their first coke.
Investor Mohnish Pabrai has described several things Buffett might’ve been looking at:
- He found that, like a software company, their gross margin on their syrup sold to bottlers is well over 80%. Coke’s future success was a function of the number of servings of coke sold worldwide. The more the servings, the more the cash flow. He found that over the last 80 years, their syrup volumes sold had risen every single year. The last 80 years included many ugly world events – World War I, the great depression, World War II, The Korean War, The Vietnam War, The Cold War, numerous recessions, being kicked out of India in the 1970s et cetera. Through all of that, Coke has grown every single year. The question Munger and Buffett posed to each other was simple – What volume of syrup might The Coca-Cola Company conservatively be expected to ship in the year 2000…2025…2050? They probably came up with some mouth-watering numbers, then extrapolated free cash flow (about one cent per eight-ounce serving) and finally arrived at a present value of all that future cash flow.
- In 1886, when Coke was first concocted, it sold for five cents per eight-ounce serving. Today, one can buy eight ounces of Coke on sale for under 17 cents. If Coke’s pricing had moved in lockstep with inflation, we’d be paying several dollars for a single can. This is a very unusual product whose unit price has declined dramatically over the years. Very few consumer products have demonstrated the level of decline in prices that Coke has over the last century.
- Billions of people around the world have yet to have their first Coke. In addition, the daily per capita consumption of bottled beverages around the world is miniscule compared to that of the United States and Europe. However, it has risen dramatically in various countries as per capita incomes have risen. We are likely to see big increases in per capita incomes in the third world over the coming decades.
The typical hammer-wielding Wall Street analyst is fixated on the next few quarters, not the next half century when trying to figure out any given company. No Wall Street analyst’s mental model of Coke in 1988 was comprised of the latticework that Munger and Buffett fixated upon. Individual investors will do well if they only made investments within their circle of competence based on an independent latticework of mental models. When all your mental models all converge at about the same intrinsic value for a given business, and that value is well above the price of the business, back up the truck.
Well enough introduction, read for yourself what Warren Buffett was reading in 1988: