I wrote an article series on Coca Cola (KO, Financial) recently and since then, I have received many comments on my articles. Most of the comments were with regards to the valuation of Coca Cola. Usually I would not take another article to respond to comments but since there appears to be some misunderstanding about my intention on writing about Coca Cola and it seems like many readers were focusing on the unintended implications from my Coca Cola articles, I think it is appropriate to make some clarifications here so that readers are not misled. In doing so I would like firstly to apologize for the impression that my articles may have left to the readers. I was ignorant of the possibility that my articles may have hinted that I was promoting Coca Cola (KO)’s common stock, which I was not.
If we look at the article right before I started writing the Coca Cola series, we can see that I came up with the idea of writing some articles on Coca Cola as an example of “understanding a business from inside out,” which was an idea I took from Lilu. In this article about Lilu, I wrote the following words:
One of the concepts that I find fascinating is – pick a business and understand it from the "inside out." A lot of times we have the illusion that we understand the business when in reality we don’t. If you don’t think this is the case, ask yourself do you really understand IBM (IBM) and Procter & Gamble (PG). Why would Warren Buffett (Trades, Portfolio) choose Coca-Cola (KO) over Procter & Gamble? You may realize that you may not understand the business as well as you thought you do. This is truly a powerful idea. In my next article, I plan to elaborate on this idea with a concrete example.
Then I chose Coca Cola (KO, Financial) as an example of how I went about understanding a business. To complement my personal insight on the business, I added many quotes from Buffett and Munger, who have probably the best knowledge about Coca Cola’s business.These quotes were supposed to help the readers understand the business model and moat of Coca Cola (KO). I regard some of the quotes great examples of second level thinking (such as the one on per ounce cost and the one on Coca's distribution channel) .
Throughout my article series, my intention was to show what the most important factors are, which drive the long term fundamental growth of Coca Cola’s business and how we can get comfortable that those factors will most likely to remain intact in the long term. I did not express the opinion that one should buy Coca Cola’s stock at the current price. If you read Part I, II, and III of my articles series, you should have covered the “understanding the business” part already. I thought it may be beneficial to add a part on the historical valuation of Coca Cola’s common stock to get a perspective on the valuation part of the business. Therefore, in the last part of my article series, I said the following, which may have resulted in some confusion:
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) over owning an index fund that tracks the performance of the Dow or the S&P 500.
What I should have added, was that I don’t own shares in Coca Cola (KO, Financial) because while it is a great business, it appears to be fairly valued and I do think there are better opportunities out there. On the other hand, on a risk-adjusted basis, I do think the risk of losing permanent capital is quite low and I do think that Coca Cola’s shareholders will do fine in the long term. This,however, in no means, implies that you should buy shares of Coca Cola. You should make your investment decisions based on your opportunity cost on a risk-adjusted basis.
Again, my apologies for having misled some of the readers. I hope this helps in terms of clarifying my intention on writing the Coca Cola article series.
