Warren Buffett (Trades, Portfolio) made a great investment in Coca-Cola (KO, Financial) in 1988. Thirty years later, it has returned roughly 1,700%. I’m pretty sure that is without dividends. Not bad. Ten percent per year plus a dividend that is probably worth a point or two over time. The goal here at the Mighty River is 11-12%.
What if our favorite investing genius purchased Pepsi (PEP, Financial) instead of Coke? It's the same basic business. Same 30 years. Instead of buying the leader, buy the No. 2 in the category.
The returns were almost identical at the 30-year mark.
What can we learn from this?
Avoid analysis paralysis
As investors, we’re often plagued by analysis paralysis. Three-hundred-page 10-Ks can do that to the best of us. We can look at businesses, especially competitive ones, in so many different ways that it can lock us up when we need to make a call. We need to identify the most important numbers that lay the foundation for long-term return on capital. Additionally, and more importantly, we have to identify the intangibles that make the business protectable in the future.
Don’t turn a situation into either/or.
Berkshire Hathaway (BRK.A)(BRK.B) shareholders would have been better served had Warren Buffett (Trades, Portfolio) purchased Pepsico and Coca-Cola. Buffett gets a pass on this, because he joined the board of Coca-Cola and there are fiduciary reasons why he couldn’t own Pepsi at the same time.
I’m not being invited to the board of most of my portfolio companies. Therefore, I don’t get that pass. Investing in Coke and not Pepsi would be a huge sin of omission in the late 1980s.
Psychologically we’re wired to pick one and not the other, but this isn’t rational at all for the investor. If you’re looking for proof today from Buffett, look at his basket bet on airlines. Delta, Southwest, United and American all are protected, in his opinion, by some moats that will guarantee returns on capital in the medium term. He didn’t waste his effort deciding if Delta was better than Southwest. That is a huge time sink because the questions can be endless.
We can spend all day thinking, comparing either/or. On the beverage business, we can ask:
· Does Pepsi or Coca-Cola have better brands?
· Did Pepsi or Coca-Cola have better management?
· Which company had better distribution capabilities?
· Is it smarter to own the bottling facilities or spin them off?
In the airline business:
· Does Delta or Southwest have better routes?
· Are more profit-driving international routes necessary for Southwest to grow?
· Which company does a better job of hedging their fuel costs?
In the mobile phone business:
· Is Safari better than Chrome?
· Does the Pixel’s better camera make it better than the iPhone?
· Is Apple’s ecosystem better than Google’s?
Hours and days later, we have fully formed points of view that are mostly useless to owning a diversified portfolio of great companies. In all of those businesses, this or that is the entirely wrong way of looking at it. It isn’t about selecting the better business of the two. It is about choosing better businesses than the broader market and purchasing them at reasonable prices. Often times, great industries produce multiple leaders that outperform. We forget this at the risk of our own pocketbook.
Where do we go from here? Which businesses are the Cokes and Pepsis for 2018? I recommend starting with the important numbers. What businesses have 50-60% gross margins? What businesses are returning 12% or higher on assets and have return on equity and return on invested capital greater than 20% over 10 to 20-year cycles? That will give you a short list.
Then move to the intangibles: Which ones have a moat-like Coca-Cola? Which ones have growth opportunities? Which ones have management that treats shareholders like owners?
Find those businesses, pay a reasonable price and you’ll beat the market by 2-4% over 30 years.
