A nagging feeling came over me while finishing this latest book with the help of my friend Scott Thompson. While I was happy with our new book "1988 valuation of Coca-Cola: Estimated Intrinsic Value," I felt like we did not fully explain the importance, value and power of that bargain purchase. How could a man who wrote a book on Buffett and Munger’s “Four Filters Invention” investing process, “Price to Value” and "MOATS," fail to understand the power of this purchase?
I started emailing friends and doing simple, somewhat crazy
math estimations to see if I could find the truth myself. I am even embarrassed
to say that I sent an email to Mr. Buffett with flawed math. Friends, with their
good intentions, would tell me to return to “Time Value of Money” calculations,
and learn those well. They would say something like, "Coca-Cola is a great
company with nice rate of returns and steadily increasing dividends, but it only
gives you a range of 9% to 11% returns."
would think, “How can that be? My investing heroes, Warren
Buffett and Charlie Munger” always smile and resist cries from shareholders
to sell the the Coca-Cola (KO) shares. What I
rediscovered is that the magic of Warren
Buffett’s and Charlie Munger’s 1988 purchase of Coca-Cola stock is: yield on
Think of yield on cost” as “yield relative to my cost” or “the
yield received per share cost” or "yield/per share cost." It can be described as
“yield/cost per share.”
I sort of backed into finding that bond concept.
My initial thinking went something like this: Think of it as getting an average
of a $570 million dividend every single year from that principal investment cost
of $1.299 billion in Coca-Cola. If you multiply $570 million x 24 years, we get
$13.15 billion. Add this $13.15 billion to the $1.29 billion principal, and we
get very, very close to the current value of $14.44 billion in BRK's ownership
Bear with me on this basic "non-compounding" math below and
you will see how Buffett received about $570 million for every year of that his
principal investment of $1.299 billion in Coca-Cola. Keep in mind, I was trying
to stay with simple math. Look at their cost of $1.299 billion, 0.44 rate of
average annual return, and 0.57, which represents my assumption of $570
0.57 x 23 (23 because of end-of-year adjustment), plus one-half
of year of approximately 0.29, so 1.299 + 13.43 = 14.73, is darn close.
found an old 2010 article that said: When Buffett began purchasing stock in Coca
Cola in 1988, many Wall Street analysts were skeptical because it seemed only a
matter of time before other beverage companies would take away its market share.
In addition, Coca-Cola had reported earnings down 2 percent from the previous
year, and had an unimpressive P/E ratio of between 14 to 19. At the time, shares
of KO were worth between $35 and $45. The stock has split three times since
then, and is now priced in the $60 range. By 1995, Buffett owned 100,000 shares
of the company with a cost basis of roughly $1.2 billion. As of September 2010,
Buffett’s unrealized gains on KO were $10.4 billion. This comes out to a 766
percent increase in value. This is one of Buffett’s greatest investing triumphs.
Using the same simple logic... When $2 grows into $6, no matter the
duration, we say 6/2=3 and 3*100 = a 300% increase in value, no matter if it
takes 1 or 900 years. In this simple math, duration is irrelevant.
by 2013, KO stock had split 4 times and BRK has 400 million shares with a cost
basis of $1.299 billion, and a market value of $14.5 billion. Forget for a
moment that it took about 24.5 years to get there. Furthermore, suspend the idea
of splits because we know the cost and the present dollar value that is already
When $1.299 billion grows to $14.500 billion, we say
14.500/1.299=11.16 and *100 is a 1,116% increase in value. Again, in simple
math, how much can we allocate to each year? Let us use a simple average and
make it even. Now, a simple rough average of 1116/24.5 years=45.55% approximate
gain per year, and this does not even count the value of the
(Next, I get a little theoretical.) Let us add in the low-ball
but fair figure of $5 billion for all the dividends (with no major time value of
money adjustments). When $1.299 grows to $19.500, we say 19.500/1.299=15.01 and
*100 is a 1,501% increase in value. Now, a simple rough average of 1501/24.5
years=61.27% gain in value (on top of the $1.29 billion) per year, or around
$570 million each year.
Now, I felt like I was getting close to why Buffett's
1988 bargain purchase of KO is so powerful and important. Next, I got a nice
email from Richard Griebe. Griebe said he was starting to see the way I was
looking at this investment in KO. “Rather than looking at the compounding of
value over time, you are looking at the average annual increase in value against
the original $1.299 billion invested. So, if I think of the original stock
purchase as buying a bond instead, that “bond” has paid a continuously
increasing interest rate over time. Following your computations to where you
included dividends to calculate an average 61.27% gain per year or, in my bond
model, Buffett bought a bond for $1.299 billion that has paid on average coupon
of 61.27% annually. This is a feat that would make gangsters jealous. Thanks for
patiently discussing this fascinating case study with me.
positive words, I felt encouraged and I thanked him. Next, I kept searching the
Internet for this “yield” concept that I was looking for. I was looking for Buffett’s
effective yield per share compared to my yield per share. I stumbled upon the
concept of yield on cost.
WOW! That is it! Yield per “share
Did I realize that 1.299 billion/400 million shares = Buffett's
$3.25 per share cost per share of KO? Did you?
From the website Investopedia, Yield on cost (YOC) is defined as: “The annual
dividend rate of a security divided by the average cost basis of the
investments. It shows the dividend yield of the original investment. If the
number of shares owned by the investor does not change, the yield on cost will
increase if the company increases the dividend it pays to shareholders;
otherwise it will remain the same."
To calculate yield on cost for a
stock, an investor must divide the stock's annual dividend by the average cost
basis per share and multiple the resulting number by 100 (to get a percentage).
For example, an investor who purchased 10 shares of stock at $15 and 20 shares
at $18 would have an average cost basis of $17 per share ($15*10 + $18*20)/(10 +
20). If the annual dividend is $0.90 per share, the yield on cost would be 5.29%
($0.90/$17 * 100).
Using this information, and knowing that Buffett's
cost per share of KO is $3.25, can I calculate his yield on cost for 2012? The
2012 dividends per share were: March 13, 2013 $0.28, Nov. 28, 2012 $0.26, Sept.
12, 2012 $0.26, June 13, 2012 $0.26, March 13, 2012 $0.26, and the sum is
So, $1.30 / $3.25 = 0.40 and 0.40 * 100 = 40%. Buffett
and Berkshire Hathaway received a 40% yield on cost just for the year 2012
Alternatively, and again thinking in bond-like thoughts,
if we believe the $570 million average return per year on top of the $1.299
billion principal. $570 million / 400 million shares is 1.43, and that is like a
gain of 43% each year over the initial investment.
Prediction: Since 45%
+ 40% = 85%, I predict that the total yearly return will soon surpass the
initial $1.29 billion cost basis of this Coca-Cola investment.