Coca-Cola is arguably one of the most successful publicly traded companies in U.S. history. Since going public in 1919 the iconic company has returned 14.1 percent per year (assuming dividends were reinvested) vs. a 10.1 percent annualized return for the U.S. stock market. However, over periods of time encompassing 10 to 20 years the returns of owning any stock like Coca-Cola can vary greatly. Much of this is related to the change in valuation of the stock during the time period in which it is owned. We cannot help but think of two words when trying to invest successfully over the long-term: Valuation Matters!
Annualized returns for investors in Coca-Cola over the past 18 years have been well below the returns achieved since 1919. From June 30, 1998 to June 30, 2016 the shares have delivered an anemic annualized return (including dividends) of 2.8 percent. Why? In June 1998 Coca-Cola’s shares were extraordinarily overvalued. The chart above compares Coca-Cola’s stock price (red line) against our estimated intrinsic value (blue line) since 1986. (We believe since Coca-Cola is an exceptional business, given its high return on invested capital and brand name, it is worth 25 times cash earnings.) In June 1998 Coca’s stock closed at $42.75. At 25 times cash earnings, its business was worth $15.29. The company’s stock was extraordinarily overvalued—trading at a 180 percent premium to our estimated intrinsic value. Fast forward to June 30, 2016 and the company, at 25 times cash earnings, was worth $44.90. The business performed admirably during this 18 year period, growing at 6.2 percent per year and paying dividends that averaged a 1.5 percent annual yield. However, from June 1998 to June 2016 the company’s stock price went from being significantly overvalued to fairly valued—appreciating at 0.3 percent per year.
As value investors, we believe over the long-run a company’s stock price will track its underlying intrinsic value. We like to buy into situations where a company’s stock is trading 20 to 50 percent below out estimated intrinsic value. We patiently wait for the market to correct its error and ideally sell when the two converge. Our recent investment in Coca-Cola illustrates this philosophy.
On March 5, 2012 we purchased shares in Coca-Cola at an average price of $34.59 in both of our equity investment strategies. At the time of our purchase, a couple of clients expressed an opinion along the lines of, “Why do you want to own Coke? Nobody drinks those sugary beverages anymore.” This is somewhat true in that the consumption of carbonated beverages in the U.S. has fallen for 13 consecutive years. However, 80 percent of Coca-Cola’s sales are outside the U.S—where consumption has been stable. More importantly, at the time of our purchase, the shares were trading 35.6 percent below our estimated intrinsic value of $53.72. We thought despite the trend of people drinking less sugary drinks it was already reflected in the low valuation of the stock. We thought if we patiently waited, Coca-Cola’s stock price and intrinsic value would converge.
On June 21st we sold our shares at $45.07—roughly in line with our estimated intrinsic value. Coke’s business has not per-formed very well during the four plus years we owned the stock as volume growth has only averaged about two percent per year and the strong dollar has weighed on foreign sales that are translated back into dollars. As a result Coca-Cola’s intrinsic value has declined from $53.72, at the time of our purchase in March 2012, to $44.90. However, we were able to achieve a respectable annualized total return of 8.7 percent on our investment in Coca-Cola, much of this realized as the result of a nar-rowing of the gap between the company’s stock price and our estimated intrinsic value.
The above post has been excerpted from a recent letter of Granite Value Capital.
This newsletter contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves the potential for gains and the risk of losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Any information prepared by any unaffiliated third party, whether linked to this newsletter or incorporated herein, is included for informational purposes only, and no representation is made as to the accuracy, timeliness, suitability, completeness, or relevance of that information. Granite Value Capital, LLC is an SEC registered investment adviser with its principal place of business in Hanover, NH. Granite Value Capital and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisers by those states in which Granite Value Capital maintains clients. Granite Value Capital may only transact business in those states in which it is notice filed, or qualifies for an exemption or exclusion from notice filing requirements. This newsletter is limited to the dissemination of general information pertaining to its investment advisory services. Any subsequent, direct communication by Granite Value Capital with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Granite Value Capital, please contact Granite Value Capital or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov).