As a value investor, you’ve sat patiently on the sidelines for years in more cash than you’d like. The moment finally comes, you purchase “Cadillacs at Chevy prices” and your stocks promptly fall 20%. No worm for the early bird. Are you an idiot?
Usually we don’t invest our money on estimated likely overruns, but instead filter our money in slowly and hope to get lucky. After all, if stocks are attractive and you don’t buy and they run away, you don’t just look like an idiot, you are an idiot.
-Jeremy Grantham of GMO
Quite right Mr. Grantham. Why would a value investor try to time the market to secure as low a price as possible?
1. We’d feel like fools if we could have purchased stocks at lower prices (and, hence, received higher returns).
2. We’d feel jealous if we know that others might get rewarded for having more patience than us.
3. We’d start to wonder if we are the “patsies at the table”.
The list goes on, but none of these things have to do with two essential facts:
1. Nobody has grown rich by making consistently correct bets on the direction of the market, a stock price or the economy. If the forecast is very certain, it’s usually arbitraged away very quickly and becomes profitless. There will be exceptions, of course, but they don’t come often.
2. All of the above reasons have nothing to do with the right way to time market purchases and this is simply by making sure you’ve paid a price that’s good for you and relative to your opportunity cost. It’s no good to talk about the fantastic returns from buying distressed mortgages, for example, if you don’t have the stomach for it. When Buffett says it’s time to buy, he isn’t timing the market, he’s telling you that you are going to get noticeably better returns than sitting in cash (or their close cousins, treasuries)…that’s all.
If I were to pick my favorite Warren Buffett quote, it would have to be:
Success in investing doesn’t correlate with I.Q. once you’re above the level of 125. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.
If you were content to use a discount rate of 10%, but 11% shows up tomorrow, this shouldn’t upset you. Your favorite stock has just gotten cheaper. Look forward to purchasing more of it. This is a satisfactory answer to somebody who will generate large amounts of cash flow relative to their existing holdings, but what if you won’t?
Controlling one’s temperament is as equally important as buying at the right price or you are left in a no-win situation:
1. You will either mistime your purchases and have a miserable experience owning a stock with a solid return due to your feelings of jealously, regret, etc.
2. You will be tempted to market time your purchases and will inevitably watch a great stock run away and never (or at least for a very long time) return back to a fair price. Then you have to go back to the market and pray that you can find something second best.
I believe that to be a good value investor you must necessarily accept the fact that you are going to walk into a investment and have to expect to get your head punched around a bit in the short term. It’s just part of the deal.
But the early bird isn’t off the hook just yet. Everything I’ve said isn’t an excuse to purchase a stock at too high a price and it’s important to know the difference when you watch your stock fall 20% and wonder whether it falls in the camp of being overpriced or just subject to short-term market whims.
The only reason not to be happy with a return is if you didn’t price the business correctly, and that, my friend, is entirely your fault.
And with that, let’s look at Coca-Cola.
A very thorough article was written recently by a Canadian student that detailed many of the risks of owning Coca-Cola. But there are more!
In using the Qanary risk detection system, one of the more remarkable risks I found (remarkable, because I never would have thought of it) was carbon dioxide.
* In the quarter, South Africa's unit case volume declined 9 percent, cycling 29 percent growth in the prior year quarter, driven by supply chain issues resulting from carbon dioxide shortages in the current quarter and the cycling of strong growth in the prior year quarter, primarily related to the replenishment of trade inventory levels due to carbon dioxide shortages in late 2006. Nigeria's unit case volume declined 1 percent in the quarter, cycling 18 percent growth in the prior year quarter, with Trademark Coca-Cola up low single digits. read more...
* Additionally, unit case volume growth for the nine months ended September 26, 2008, reflected the impact of a 3 percent volume decline in South Africa during the first nine months of 2008, primarily due to supply chain issues that were the result of carbon dioxide shortages. read more...
In other words, Coca-Coca suffered volume declines in one of their faster growing markets because they didn’t have enough “fizz”. This issue was identified well over a year ago and the solution was finally to build their own fizzy manufacturing plant. Flat Coca-Cola no more.
I grant you that this risk is more amusing than frightening, but given the ease of enumerating risks in Qanary, I feel better for knowing that there’s one less thing that will give me a headache when I read tomorrow’s news.
Let’s get to something meatier, the weather. [Water quality, for the record, would have been my next pick to discuss, but it was already mentioned in the above article and you can get a free account on Qanary to see it for yourself along with many other risks.]
* Additionally, significant portions of the European Union were adversely impacted by unfavorable weather during the second quarter. read more...
* Japan also realized unit case volume declines during the quarter and for the first six months of 2008 in Sokenbicha and Aquarius, primarily related to unfavorable weather. read more...
* The Pacific Group increased unit case volume 4 percent in the quarter, cycling 9 percent growth in the prior year quarter, and reflected the impact from natural disasters and unfavorable weather. read more...
Asia and Europe sales got hurt by weather; it is clearly not an imaginary or unlikely factor in the fortunes of Coca-Cola. Having a Coke is less satisfying in cold weather, that’s common sense.
I wondered to myself, though, whether the effects of global warming might not improve their future business prospects? A quick query on Google turned up nothing, specifically. So, is this a risk or merely a point of sensitivity that, in fact, is quite promising to their business [with apologies, of course, to being inconsiderate about the negative consequences of global warming]? I leave that for the reader to consider.
In examining the intersection of today’s risks, though, I dug up this interesting article on the effects of Coca-Cola on global warming. Coca-Cola is know to be aggressively trying to reduce their greenhouse gas emissions, but the implication here is that carbon dioxide mightn't be as trivial a risk as we thought. That these two risk were tied together specifically for Coca-Cola was an interesting surprise. Will Coca-Cola have to pay a further price for emissions? Will somebody create a scare/misinformation that they're responsible for global warming? If I were cooking conspiracy theory, I might think they've built a mechanism into their product and operations that ensures its own success!
I love Coca-Cola and it is pretty well understood, but let’s go back to the original theme of this article…are we being early birds in buying Coca-Cola?
Using very, very rough back of the envelope calculations, Coca-Cola has trailing free cash flows of about $5.5-6B. Their growth isn’t as blockbuster as it was when Buffett picked it up in the late eighties (it’s been an 8.51% CAGR over the last 5 years). I don’t think anybody can argue performance that is significantly higher or lower than this number in the upcoming years (barring a collapse in the US dollar). I’m a little conservative, though, so let’s assume 6% growth for the next 10 years and a terminal rate of 3%. I get a 10.75% annual return at today’s closing price (around $43) and it doesn’t have a significant margin of safety built into it on the price.
Are you happy with the return compared to your other options? Will you be happy if KO falls lower? and will you be upset if KO shoots up in price and never returns to this pricing level again? No value investing guru can tell you that.
Usually we don’t invest our money on estimated likely overruns, but instead filter our money in slowly and hope to get lucky. After all, if stocks are attractive and you don’t buy and they run away, you don’t just look like an idiot, you are an idiot.
-Jeremy Grantham of GMO
Quite right Mr. Grantham. Why would a value investor try to time the market to secure as low a price as possible?
1. We’d feel like fools if we could have purchased stocks at lower prices (and, hence, received higher returns).
2. We’d feel jealous if we know that others might get rewarded for having more patience than us.
3. We’d start to wonder if we are the “patsies at the table”.
The list goes on, but none of these things have to do with two essential facts:
1. Nobody has grown rich by making consistently correct bets on the direction of the market, a stock price or the economy. If the forecast is very certain, it’s usually arbitraged away very quickly and becomes profitless. There will be exceptions, of course, but they don’t come often.
2. All of the above reasons have nothing to do with the right way to time market purchases and this is simply by making sure you’ve paid a price that’s good for you and relative to your opportunity cost. It’s no good to talk about the fantastic returns from buying distressed mortgages, for example, if you don’t have the stomach for it. When Buffett says it’s time to buy, he isn’t timing the market, he’s telling you that you are going to get noticeably better returns than sitting in cash (or their close cousins, treasuries)…that’s all.
If I were to pick my favorite Warren Buffett quote, it would have to be:
Success in investing doesn’t correlate with I.Q. once you’re above the level of 125. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.
If you were content to use a discount rate of 10%, but 11% shows up tomorrow, this shouldn’t upset you. Your favorite stock has just gotten cheaper. Look forward to purchasing more of it. This is a satisfactory answer to somebody who will generate large amounts of cash flow relative to their existing holdings, but what if you won’t?
Controlling one’s temperament is as equally important as buying at the right price or you are left in a no-win situation:
1. You will either mistime your purchases and have a miserable experience owning a stock with a solid return due to your feelings of jealously, regret, etc.
2. You will be tempted to market time your purchases and will inevitably watch a great stock run away and never (or at least for a very long time) return back to a fair price. Then you have to go back to the market and pray that you can find something second best.
I believe that to be a good value investor you must necessarily accept the fact that you are going to walk into a investment and have to expect to get your head punched around a bit in the short term. It’s just part of the deal.
But the early bird isn’t off the hook just yet. Everything I’ve said isn’t an excuse to purchase a stock at too high a price and it’s important to know the difference when you watch your stock fall 20% and wonder whether it falls in the camp of being overpriced or just subject to short-term market whims.
The only reason not to be happy with a return is if you didn’t price the business correctly, and that, my friend, is entirely your fault.
And with that, let’s look at Coca-Cola.
A very thorough article was written recently by a Canadian student that detailed many of the risks of owning Coca-Cola. But there are more!
In using the Qanary risk detection system, one of the more remarkable risks I found (remarkable, because I never would have thought of it) was carbon dioxide.
* In the quarter, South Africa's unit case volume declined 9 percent, cycling 29 percent growth in the prior year quarter, driven by supply chain issues resulting from carbon dioxide shortages in the current quarter and the cycling of strong growth in the prior year quarter, primarily related to the replenishment of trade inventory levels due to carbon dioxide shortages in late 2006. Nigeria's unit case volume declined 1 percent in the quarter, cycling 18 percent growth in the prior year quarter, with Trademark Coca-Cola up low single digits. read more...
* Additionally, unit case volume growth for the nine months ended September 26, 2008, reflected the impact of a 3 percent volume decline in South Africa during the first nine months of 2008, primarily due to supply chain issues that were the result of carbon dioxide shortages. read more...
In other words, Coca-Coca suffered volume declines in one of their faster growing markets because they didn’t have enough “fizz”. This issue was identified well over a year ago and the solution was finally to build their own fizzy manufacturing plant. Flat Coca-Cola no more.
I grant you that this risk is more amusing than frightening, but given the ease of enumerating risks in Qanary, I feel better for knowing that there’s one less thing that will give me a headache when I read tomorrow’s news.
Let’s get to something meatier, the weather. [Water quality, for the record, would have been my next pick to discuss, but it was already mentioned in the above article and you can get a free account on Qanary to see it for yourself along with many other risks.]
* Additionally, significant portions of the European Union were adversely impacted by unfavorable weather during the second quarter. read more...
* Japan also realized unit case volume declines during the quarter and for the first six months of 2008 in Sokenbicha and Aquarius, primarily related to unfavorable weather. read more...
* The Pacific Group increased unit case volume 4 percent in the quarter, cycling 9 percent growth in the prior year quarter, and reflected the impact from natural disasters and unfavorable weather. read more...
Asia and Europe sales got hurt by weather; it is clearly not an imaginary or unlikely factor in the fortunes of Coca-Cola. Having a Coke is less satisfying in cold weather, that’s common sense.
I wondered to myself, though, whether the effects of global warming might not improve their future business prospects? A quick query on Google turned up nothing, specifically. So, is this a risk or merely a point of sensitivity that, in fact, is quite promising to their business [with apologies, of course, to being inconsiderate about the negative consequences of global warming]? I leave that for the reader to consider.
In examining the intersection of today’s risks, though, I dug up this interesting article on the effects of Coca-Cola on global warming. Coca-Cola is know to be aggressively trying to reduce their greenhouse gas emissions, but the implication here is that carbon dioxide mightn't be as trivial a risk as we thought. That these two risk were tied together specifically for Coca-Cola was an interesting surprise. Will Coca-Cola have to pay a further price for emissions? Will somebody create a scare/misinformation that they're responsible for global warming? If I were cooking conspiracy theory, I might think they've built a mechanism into their product and operations that ensures its own success!
I love Coca-Cola and it is pretty well understood, but let’s go back to the original theme of this article…are we being early birds in buying Coca-Cola?
Using very, very rough back of the envelope calculations, Coca-Cola has trailing free cash flows of about $5.5-6B. Their growth isn’t as blockbuster as it was when Buffett picked it up in the late eighties (it’s been an 8.51% CAGR over the last 5 years). I don’t think anybody can argue performance that is significantly higher or lower than this number in the upcoming years (barring a collapse in the US dollar). I’m a little conservative, though, so let’s assume 6% growth for the next 10 years and a terminal rate of 3%. I get a 10.75% annual return at today’s closing price (around $43) and it doesn’t have a significant margin of safety built into it on the price.
Are you happy with the return compared to your other options? Will you be happy if KO falls lower? and will you be upset if KO shoots up in price and never returns to this pricing level again? No value investing guru can tell you that.
