Coca Cola increased their yearly dividend today to $1.76 per share from $1.68 per share, a 4.8% increase.
This means another $32 million goes into Berkshire’s coffers and total dividends for the year are $704 million.
Berkshire invested $1 billion into KO in 1988. That was an enormous investment back then but basically a bar tip now.
Time is the friend of a good business and the enemy of a lousy one. Compounding can be an incredible thing.
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Jim can check me on this but I believe (and again I may be wrong) that within 3 or 4 years Buffett’s Coke investment was worth more than all of Berkshire when he made it. But I’m old now and fantasy sometimes replaces fact!
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I hear you BD- Amazing 54% annual yield currently, relative to our initial cost basis of 1.3B or $3.2475/share. KO was nearly a 10 bagger by 2000 (12.2B) when it was overvalued and should have trimmed/ sold, but it’s been a pretty nice ride! Funny WEB still drinks 5 Cokes/ day and used to drink Pepsi way back.
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Coke was certainly once a great company and a great investment.
FWIW, last ten years:
Real growth in total sales: -4.0%/year
Real growth in sales per share: -3.6%/year
Real growth in total profit: -1.0%/year
Real growth in EPS: -0.3%/year
Real growth in cash flow per share: -1.2%/year
Real growth in shareholders’ equity: -5.3%/year
Real growth in debt: +8.9%/year
The dividend payout ratio has gone from 51% in 2005 to about 75%, with a forgiveable spike to 84% in 2020.
What can one say that’s nice?
- They’re not going anywhere. Longevity counts for a lot.
- Net margins have improved in this stretch.
- It’s a stable enough business that they can support their habit of borrowing more and more to pay rising dividends from falling profits, eroding the capital base.
For a while, anyway. - It’s a useful US dollar hedge, since most of their costs are US based and 2/3 of their revenues are ex-US.
Jim
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Misleading. Sold bottling assets>>>became less capital intensive and distorts financials
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Hi Jim,
I agree with your assessment about KO. The numbers you mentioned are in line with those reported in Valueline. However, in the last 10 years, KO’s return on equity has ranged from 27.5% (in 2012) to 52.6% (in 2018) with an average of 42.17%. Hence, I am struggling to make sense of these numbers. How can KO’s EPS and cash flow growth rate be so low when the ROE is so high?
Thanks!
P.S.: Their return on total capital invested in the last 10 years has been in the high double digits, which is decent (e.g., it is more than double that of the S&P 500).
I agree with your assessment about KO. The numbers you mentioned are in line with those reported in Valueline. However, in the last 10 years, KO’s return on equity has ranged from 27.5% (in 2012)
to 52.6% (in 2018) with an average of 42.17%. Hence, I am struggling to make sense of these numbers.
How can KO’s EPS and cash flow growth rate be so low when the ROE is so high?
A high ROE is a sign that a company might have very good underlying business economics.
Especially if it’s showing no signs of falling over time, on a rising capital base (rising shareholders’ book value).
But only a sign.
The reason it works is: if the shareholders’ equity is rising, and the ROE is high and not falling, then you know two things are highly probable:
- competitors are not succeeding in trying to compete with them, which would drive down returns for both parties. In other words, a moat.
- it shows the firm is able to deploy new capital at those same high rates of return, a very good thing.
But you have to look at what the numbers mean in each case.
In Coke’s case, the rising ROE doesn’t rescue a business that is, it would seem, very slowly shrinking. Certainly not growing in real terms.
The ROE numbers look good mainly because the shareholders’ equity is evaporating. They’re paying it out in dividends.
Divide profits by a smaller number over time, you get a higher ROE over time. The arithmetic is simple and solid, but the conclusions are sometimes less obvious.
They can get away with that because the earnings stream is formidably secure and long lasting.
But it isn’t a sign of great and improving economics in the business.
To the extent that that payout of the equity is being funded by debt rather than owner earnings, it has to come to an end at some point.
Eventually interest charges (or the risk of them should rates rise) start eroding the earnings too much.
At the current size of the debt pile, an interest rate rise to 5% would wipe out about 20% of profits.
Long story short: never bother to even look at the ROE of a firm unless you know their leverage is very modest/safe.
In this case the leverage is fine, but it’s on trajectory that might be a problem at some point.
Jim
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Thank you, Jim. This is very helpful. Indeed, upon closer inspection, their shareholder’s equity has fallen from 31.6 billion in 2011 to 19.2 billion in 2020.
I appreciate the insight.
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In Coke’s case, the rising ROE doesn’t rescue a business that is, it would seem, very slowly shrinking. Certainly not growing in real terms.
The ROE numbers look good mainly because the shareholders’ equity is evaporating. They’re paying it out in dividends.
I sold all my Coke stock recently after coming to the same conclusion. The dividend appears to be propping up the stock price, but the dividend cannot rise indefinitely (or even be maintained) in a shrinking business. At some point the party has to stop.
A modest rise in interest rates might mean that the dividend has to be cut just at the moment when the yield would need to rise, giving a double-whammy effect to the stock price.
If / when that happens, then the stock price might never recover to its previous highs in real terms, given the steady decline in the business.
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Berkshire’s approach to holding companies and shares of companies for a very long time is interesting and the Coke position is one of the examples.
When Buffett and Munger talk about ignoring the current market bid and instead focus on the cash flows, they really mean it.
This is a double edged sword. On the one hand they know that eventually the cash flow will start to decline. Sometimes suddenly like Worldbook and others very slowly like Coke. Of course when the market senses things are in decline the market value for the business can and usually does fall rapidly. This has not really been the case with Coke. I guess the market just sees the death of cash flows as predictable and extremely protracted. Maybe even eventually finding a plateau of supper slow decline or even just no volume growth. In the situations like Coke and Worldbook it seems like having missed out on the exit multiple, you have really screwed up the investment. But of course it’s hard to know in advance what is about to happen to your cash flows and when the start to dry up, it’s too late to sell.
On the other hand if you try to buy businesses with great and enduring economics and resolve to hold for ever in most circumstances, you get the benefit of 20 or 50 years or more of those great economics if they turn out to be quite sustainable. This is obviously considered way more valuable on a portfolio basis that moving in and out. Some businesses will fade away, some will die suddenly but if you were a good allocator, many with be home runs. And that is why you hold.
I guess writing the above teases out something important for me personally. Which is that, although I hate diversification, not because I’m some great Buffett/Munger like investors but if I’m honest, because it has the potential for bigger outsized returns. But what I take from this, is that some diversification is really important as even Buffett and Munger can’t predict the future with 100% accuracy.
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Tobacco has been a declining business for over 50 years but yet it has been a great investment. I am a longtime holder of KO with no plans to sell.
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It seems to me that tobacco is a fundamentally different business.
For example, the EPS of MO went from $1.64 in 2011 to $4.60 in 2021, a compounded increase of 11% per annum. During this period, MO also paid significant dividends (currently, about 7%).
In contrast, as Jim outlined above, the EPS of KO has been flattish during the last 10 years, while paying significantly lower dividends than MO (currently, about 2.8%).
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again, misleading. KO has moved to an Asset Lite business model. Shed bottling.
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again, misleading. KO has moved to an Asset Lite business model. Shed bottling.
Didn’t they buy it not that long ago, then ditch it again?
Maybe I misremember…
Either way, it may have messed up ROE calculations, but neither move helped the bottom line in any obvious way.
Oddly enough, Coke would be a very much better long run prospect if the valuation multiples crashed in a lasting way.
They could put money into buybacks at a decently high rate of return.
One time drop from the drop in multiples, but then a better very long run rate of return thereafter.
The real pessimist would find a flaw in that argument: what money would that be?
They do retain earnings every year, but the total earnings in real terms aren’t rising. ROIIC rounds to zero, it seems.
The simple/pessimist view of that dynamic is that all the retained earnings are “running to stay in place”:
they’re going into keeping the competitive position, and the dividends very roughly equal the owner earnings.
i.e., there are no “extra” retained earnings available for expansion capex or buybacks.
But hey, times are good at the moment.
Earnings are back up over $2 again.
Maybe it’s a sign of a brighter future.
Jim
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I haven’t looked at KO in a while. It has really become mediocre. The brand is great and it isn’t going anywhere, but not anywhere good either.