Coca-Cola is Warren Buffett's oldest stock position at Berkshire Hathaway. It's also providing some of the best returns, with the stock up over 2,000% since the Oracle of Omaha started buying it 33 years ago. Modern investors looking to navigate the next decade would be well-served to learn how Buffett made this profitable calculation.
At a recent Yahoo Finance Plus webinar, Bill Smead, chief investment officer at Smead Capital Management, began the lesson by explaining how Buffett manages growth and value in the Berkshire portfolio.
"To Buffett and [Charlie] Munger, all investing is value investing. They want to buy the bird in the hand, which is worth two in the bush. They want to buy something for well less than they think it's worth. So the ideal thing in investing is based on the mathematics of common stock investing. If you buy a stock for $30 and you pay cash, the worst thing that could possibly happen to you is it goes to zero. But the best thing that could possibly happen to you is exponential," says Smead.
Smead explains how Buffett and Munger differ from legendary value investor Benjamin Graham and why value and growth aren't mutually exclusive. Graham would "buy 200 cigar butts at half the price that they're worth, and through the market's movements [would] get wealthier doing that," says Smead.
Buffett, on the other hand, wants to "buy a business that is growing over the decades at a time when other people are scared to death or don't understand why it's going to be such a good thing over the next 20 or 30 years — and then enjoy a double whammy, which is the re-evaluation." Smead explains this is "the price that people are willing to pay for each dollar of earnings growth as well as the earnings number [itself] grows."
Coca-Cola a risky bet
Berkshire first bought Coke stock from 1988 to 1989, scooping up over 23 million shares. When Buffett first started buying in the first quarter, many investors were still skittish from the Black Monday crash in October 1987. Buffett going big on the stock was considered risky, especially because it was not a typical Berkshire investment.
Buffett defended the position in the 1988 annual Berkshire letter to shareholders with what would become one of his most famous aphorisms. "In 1988 we made major purchases of Federal Home Loan Mortgage ... and Coca Cola. We expect to hold these securities for a long time. In fact, when we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever," said Buffett.
Berkshire more than quadrupled the position to 100 million shares by 1994 and to this day hasn't sold any. After two stock splits, the share count is now 400 million, but Berkshire's cost basis has remained $1.3 billion since 1994. As of year-end 2020, the investment was worth $21.5 billion, a return of 1550%, not including dividends. (Berkshire owns 9.3% of all Coke shares outstanding as of 2020 year-end.)
But the 1987 crash hangover had faded for Buffett, and the world was changing. The Soviet empire was beginning to crumble, and the Berlin Wall was about to topple — which it finally did in November 1989.
Smead relates his own experience as a broker in the 1980s to Buffett, saying, "Buffett [was buying] Coca-Cola in '89 at about 18 times earnings. Well, I started in the investment business in 1980 as a stockbroker at Drexel Burnham Lambert. And my first stock that I was pitching to people was Coca-Cola — $30 a share. It was at six times earnings paying a 5% dividend. When Buffett bought in eight years later, he paid six times what I was trying to pay for it."
Smead explains how investor sentiment changed throughout the 1980s, as memories of the tumultuous 1970s faded and morphed into optimism over a bull market that would become one of history's longest and most profitable.
"I would be destitute and living in a tent in downtown Phoenix or Downtown Seattle if I kept pitching [Coca-Cola] stock because no one would buy it. Virtually, no one wanted it. Common stock ownership in 1981 was 8% of U.S. household assets — off the charts low. No one wanted that company," he says.
Smead explains how the changing political environment would also change the macro picture, providing new opportunities and markets for companies. "[A] number of countries that used to be closed were going to open their doors. And the Coca-Cola corporation was going to be able to sell their beverages to a huge part of the population that they had never sold it to before. And in emerging markets and less wealthy countries, that 'clean, something to drink' was very valuable."
New investment opportunities post-COVID
In the present day, the pandemic has thrown the macro picture into upheaval again, presenting investors with a new set of challenges. Smead assesses the demographic changes afoot and sets the stage for what he believes are new, secular investment opportunities.
"We looked at the prior time when the 30- to 45-year-old-age group was dramatically larger than the previous group, the ones that preceded them. And that was the baby boomers taking the place of the silent generation in the 70s and 80s ... And we now have 90 million millennials — not too long from now, 95 million — that are going to take 65 million Gen Xers place in the 30- to 45-year-old age bracket. So that just creates a huge amount of demand for necessities," he says.
Smead references research from Fundstrat Global Advisors that ranks the industries it expects millennials to disrupt as their spending eclipses that of boomers. "At the top of that list is mortgage interest and finance charges. So long before it was in the news, long before it was popular to think about, we have been over-owning the homebuilders, knowing that we have years of building homes to make up the differential between demand for homes, that population will drive the existing homes for sale," Smead says.
Smead expects stock pickers to outperform passive investors over the coming decade. He also sees the footwear and household furnishings and equipment industries to outperform based on the same demographic trends relating to homebuilders.
"[T]he irony of the pandemic is: It's actually catalyzed one of our most important themes, which is the necessity spending of the millennial age group," says Smead.