Bud Labitan

# Yield on Cost Is Warren Buffett’s Coca-Cola Magic

A nagging feeling came over me while finishing this latest book with the help of my friend Scott Thompson. While I was happy with our new book "1988 valuation of Coca-Cola: Estimated Intrinsic Value," I felt like we did not fully explain the importance, value and power of that bargain purchase. How could a man who wrote a book on Buffett and Munger’s “Four Filters Invention” investing process, “Price to Value” and "MOATS," fail to understand the power of this purchase?

I started emailing friends and doing simple, somewhat crazy math estimations to see if I could find the truth myself. I am even embarrassed to say that I sent an email to Mr. Buffett with flawed math. Friends, with their good intentions, would tell me to return to “Time Value of Money” calculations, and learn those well. They would say something like, "Coca-Cola is a great company with nice rate of returns and steadily increasing dividends, but it only gives you a range of 9% to 11% returns."

I would think, “How can that be? My investing heroes, Warren Buffett and Charlie Munger” always smile and resist cries from shareholders to sell the the Coca-Cola (NYSE:KO) shares. What I rediscovered is that the magic of Warren Buffett’s and Charlie Munger’s 1988 purchase of Coca-Cola stock is: yield on cost.

Think of yield on cost” as “yield relative to my cost” or “the yield received per share cost” or "yield/per share cost." It can be described as “yield/cost per share.”

I sort of backed into finding that bond concept. My initial thinking went something like this: Think of it as getting an average of a \$570 million dividend every single year from that principal investment cost of \$1.299 billion in Coca-Cola. If you multiply \$570 million x 24 years, we get \$13.15 billion. Add this \$13.15 billion to the \$1.29 billion principal, and we get very, very close to the current value of \$14.44 billion in BRK's ownership of Coca-Cola.

Bear with me on this basic "non-compounding" math below and you will see how Buffett received about \$570 million for every year of that his principal investment of \$1.299 billion in Coca-Cola. Keep in mind, I was trying to stay with simple math. Look at their cost of \$1.299 billion, 0.44 rate of average annual return, and 0.57, which represents my assumption of \$570 million.

0.57 x 23 (23 because of end-of-year adjustment), plus one-half of year of approximately 0.29, so 1.299 + 13.43 = 14.73, is darn close.

I found an old 2010 article that said: When Buffett began purchasing stock in Coca Cola in 1988, many Wall Street analysts were skeptical because it seemed only a matter of time before other beverage companies would take away its market share. In addition, Coca-Cola had reported earnings down 2 percent from the previous year, and had an unimpressive P/E ratio of between 14 to 19. At the time, shares of KO were worth between \$35 and \$45. The stock has split three times since then, and is now priced in the \$60 range. By 1995, Buffett owned 100,000 shares of the company with a cost basis of roughly \$1.2 billion. As of September 2010, Buffett’s unrealized gains on KO were \$10.4 billion. This comes out to a 766 percent increase in value. This is one of Buffett’s greatest investing triumphs.

Using the same simple logic... When \$2 grows into \$6, no matter the duration, we say 6/2=3 and 3*100 = a 300% increase in value, no matter if it takes 1 or 900 years. In this simple math, duration is irrelevant.

Now, by 2013, KO stock had split 4 times and BRK has 400 million shares with a cost basis of \$1.299 billion, and a market value of \$14.5 billion. Forget for a moment that it took about 24.5 years to get there. Furthermore, suspend the idea of splits because we know the cost and the present dollar value that is already split-adjusted.

When \$1.299 billion grows to \$14.500 billion, we say 14.500/1.299=11.16 and *100 is a 1,116% increase in value. Again, in simple math, how much can we allocate to each year? Let us use a simple average and make it even. Now, a simple rough average of 1116/24.5 years=45.55% approximate gain per year, and this does not even count the value of the dividends.

(Next, I get a little theoretical.) Let us add in the low-ball but fair figure of \$5 billion for all the dividends (with no major time value of money adjustments). When \$1.299 grows to \$19.500, we say 19.500/1.299=15.01 and *100 is a 1,501% increase in value. Now, a simple rough average of 1501/24.5 years=61.27% gain in value (on top of the \$1.29 billion) per year, or around \$570 million each year.

Now, I felt like I was getting close to why Buffett's 1988 bargain purchase of KO is so powerful and important. Next, I got a nice email from Richard Griebe. Griebe said he was starting to see the way I was looking at this investment in KO. “Rather than looking at the compounding of value over time, you are looking at the average annual increase in value against the original \$1.299 billion invested. So, if I think of the original stock purchase as buying a bond instead, that “bond” has paid a continuously increasing interest rate over time. Following your computations to where you included dividends to calculate an average 61.27% gain per year or, in my bond model, Buffett bought a bond for \$1.299 billion that has paid on average coupon of 61.27% annually. This is a feat that would make gangsters jealous. Thanks for patiently discussing this fascinating case study with me.

With Griebe’s positive words, I felt encouraged and I thanked him. Next, I kept searching the Internet for this “yield” concept that I was looking for. I was looking for Buffett’s effective yield per share compared to my yield per share. I stumbled upon the concept of yield on cost.

WOW! That is it! Yield per “share cost.”

Did I realize that 1.299 billion/400 million shares = Buffett's \$3.25 per share cost per share of KO? Did you?

From the website Investopedia, Yield on cost (YOC) is defined as: “The annual dividend rate of a security divided by the average cost basis of the investments. It shows the dividend yield of the original investment. If the number of shares owned by the investor does not change, the yield on cost will increase if the company increases the dividend it pays to shareholders; otherwise it will remain the same."

To calculate yield on cost for a stock, an investor must divide the stock's annual dividend by the average cost basis per share and multiple the resulting number by 100 (to get a percentage). For example, an investor who purchased 10 shares of stock at \$15 and 20 shares at \$18 would have an average cost basis of \$17 per share (\$15*10 + \$18*20)/(10 + 20). If the annual dividend is \$0.90 per share, the yield on cost would be 5.29% (\$0.90/\$17 * 100).

Using this information, and knowing that Buffett's cost per share of KO is \$3.25, can I calculate his yield on cost for 2012? The 2012 dividends per share were: March 13, 2013 \$0.28, Nov. 28, 2012 \$0.26, Sept. 12, 2012 \$0.26, June 13, 2012 \$0.26, March 13, 2012 \$0.26, and the sum is \$1.30

So, \$1.30 / \$3.25 = 0.40 and 0.40 * 100 = 40%. Buffett and Berkshire Hathaway received a 40% yield on cost just for the year 2012 dividends alone!

Alternatively, and again thinking in bond-like thoughts, if we believe the \$570 million average return per year on top of the \$1.299 billion principal. \$570 million / 400 million shares is 1.43, and that is like a gain of 43% each year over the initial investment.

Prediction: Since 45% + 40% = 85%, I predict that the total yearly return will soon surpass the initial \$1.29 billion cost basis of this Coca-Cola investment.

 Currently 3.94/512345 Rating: 3.9/5 (35 votes)

Hasagos - 4 years ago
Excellent analysis and conclusion, though your math is much too complicated for me to understand/comprehend.

LwC - 4 years ago    Report SPAM
However, IMO the real current yield on the KO investment probably should be considered to be the return on the assumed after tax value of the shares at current market price; not nearly as high as assuming return on the original cost of the shares.

Fmurphy - 4 years ago

Also by not taking a realized gain on KO, he is benefiting from compounding on money that

would otherwise be paid to the government in the form of capital gains taxes.
Traderatwork - 4 years ago    Report SPAM
I suspect the answer is much simpler:

1. Is KO a company that will still exist for a long time - Yes

2. Does it make money?

3. What is guestimate of the EPS long term growth rate - will it be 3% or more? If yes- one can pay for PE ~=13 to 15 (according to Graham Growth formula 8.5 + 2G) and KO growth rate in 1987/88 is the about 12%

So in 1988 even KO is selling for PE=20 it is still cheap. I don't think the dividend will bother Buffett as long as they put the earning to work.
Toponemike - 4 years ago    Report SPAM
The dividend paid out last year was \$1.02 not \$1.3
John Huber - 4 years ago
Excellent article. Just one small point that is a minor pet peeve of mine. I see this error all the time. If \$2 turns into \$6, its a 200% (not 300%) return. If a stock triples, it made 200%. That's often mistaken. But I thought the post was excellent. Yield on cost is a great thing to consider with compounders. Buffett mentioned this in his 2010 letter
Valu2day - 4 years ago
Bud,

KO split 2 for 1 in 2012, therefore you need to adjust the dividend, which as a previous poster stated should be \$1.02 in 2012.
Valu2day - 4 years ago
You also need to adjust Berkshire's cost basis per share, which would be split adjusted to \$1.625 per share. This would change the YOC to 62.77% for 2012. Not too shabby!

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