A few days ago, one reader was kind enough to remind me that I haven’t finished my article series on the Coca Cola Company (KO, Financial).
Oops, I did forget about it. So first of all, my apologies for having forgotten that I left my article series unfinished. Now it’s time to for me make up for my tardiness and forgetfulness before Santa comes.
Let’s get back to the Coca Cola Company. In my previous articles, I talked about the insight from other great investors, Coca Cola’s bottling operation, and the most important factors in order to understand the business. I left out the valuation part. Therefore, this article is my attempt to tackle the rough valuation part of Coca Cola. In doing so, I am reminded of two timeless thoughts on investing:
- It is better to be roughly right than precisely wrong.
- Most of the time, a stock trades in the zone of fair-value-ness but occasionally the valuation gets to the extremes.
With those wise words in mind, I’ve decided that my goal in this article is to be roughly right and to identify the extreme valuation levels with regards to the Coca Cola Company.
In Part III of the article series, I’ve discussed the most important fundamental factors underlying Coca Cola’s business – unit case growth, pricing power, ubiquitousness and availability, and share count reduction. The combination of these factors have enabled the business not onlyl to earn an above average return on tangible assets, invested capitals and equity, but also to grow revenue at high single digits rate and earnings per share in the low teens range over the long run. Obviously with such a wonderful business, it should trade at a premium relative to average business as well as the index.
Below is a Factset chart that shows Coca Cola’s stock price as well as its P/E ratio since 1985. The P/E ratio reflect adjustment to earnings by Factset so it may not be consistent with what you may otherwise get from other data sources but by and large, it’s good enough for our discussion.
Now, even an idiot can tell that Coca Cola’s P/E ratio rarely drops below 18 and it also doesn’t stay above 50 for a long time either. Most of the time, it oscillates between 20 and 30. By Graham’s standard, Coca Cola almost never looked cheap. Now I want you to focus on 1988 and 1998. As you can tell, Coca Cola’s P/E dipped below 18 during 1988 and shot above 50 during 1998. I think it’s safe to say that during these two years, Coca Cola’s price deviated significant from the fair value zone and fell into the extremes. Incidentally, Buffett and Munger purchased Coca Cola in 1988. And unfortunately for many investors who bought Coca Cola in 1988, their money was dead for more than a decade.
| Month/ Year | Adjusted KO’s Ending Price (Data from Yahoo Finance) |
| June 1998 | 29.38 |
| June 1999 | 21.51 |
| June 2000 | 20.17 |
| June 2001 | 16.02 |
| June 2002 | 20.26 |
| June 2003 | 17.11 |
| June 2004 | 18.98 |
| June 2005 | 16.10 |
| June 2006 | 17.05 |
| June 2007 | 21.30 |
| June 2008 | 21.69 |
| June 2009 | 20.73 |
| June 2010 | 22.35 |
| June 2011 | 30.89 |
Another time period of extreme valuation was obviously during the nifty-fifty craziness. Coca Cola’s stock was essentially flat from 1973 to 1983. During the nifty-fifty bubble, Coca Cola’s share was selling at $75 a share while it only earned a little over $1.50. So it was selling for more than 50 times earnings.
The most recent deviation from fair value zone came along with the financial crisis as well as argubly the few years after the crisis when the P/E dropped below 18 multiple times. Again, a P/E ratio of 18 may not sound cheap but history has showed us buying KO at a P/E level below 18 is likely to work out very well in the long run.
Again, I don’t claim that I am right but I think the above analysis is a good educated guess based on my understanding of the fundamentals fo the business and the history of the stock price and P/E ratio of Coca Cola’s common stock. The Pavlovian conditioning Coca Cola has built over more than 100 years, reinforced by the social proof of seeing those around us drink it and the ease of its universal availability, makes Coca Cola the best among the best in the business world. At today’s price, I would argue that Coca Cola’s stock is trading at the lower end of the zone-of-fairness with P/E a little over 20 times. The Dow and the S&P 500 index are both probably at the higher end of the zone-of-fairness. If Coca Cola can continue to earn an above average return on capital and continue to grow faster than an average company in the index with a lower risk profile, at today’s price, I would vastly prefer owning the common stock of Coca Cola (KO, Financial) over owning an index fund that tracks the performance of the Dow or the S&P 500.
This concludes my series on the Coca Cola Company.
