- Berkshire Hathaway's stake in Coca-Cola has increased to 9.3%.
- Coca-Cola's EPS growth and stock performance have not been particularly impressive.
- But it is a dividend powerhouse that is positioned to continue rewarding shareholders through higher payouts.
Legendary investor Warren Buffett remains a firm believer in Coca-Cola (NYSE:KO). The Oracle of Omaha’s latest letter to shareholders revealed that his company, Berkshire Hathaway (NYSE:BRK.A), which was already Coca-Cola’s single largest institutional investor, has seen its stake grow in the iconic beverage maker.
In his annual letter to shareholders, Warren Buffett wrote that Berkshire Hathaway’s stake in Coca-Cola has grown from 9.2% to 9.3%, entirely due to buybacks which decrease the total number of outstanding shares. Berkshire Hathaway’s ownership of Coca-Cola shares (number of shares) has remained unchanged for more than two decades except in cases of splits, etc.
The increase in stake seems insignificant until we expand our time horizon. In 1994, when Berkshire Hathaway bought an additional 26.4 million Coca-Cola shares to increase its ownership to 400 million shares, it owned 7.8% of the company. Since then, Warren Buffett has been sitting on the sidelines while Coca-Cola has been buying back stock. Since 2010, Berkshire Hathaway’s stake has grown by at least 0.1 percentage point each year. At this rate, it won’t be long before its stake increases to double-digits.
But on paper, it appears Coca-Cola’s performance has not been particularly impressive. The company’s earnings per share (EPS) growth rate has not been very consistent. Profits have been going downhill for the last two years. The annual performance of the Coca-Cola stock also lacks consistency when compared against the broader S&P-500. The stock has underperformed the S&P-500 in 4 out of the last eleven years.
Note: EPS growth as adjusted.
The poor run has particularly hit those investors who put their money in the Coca-Cola stock in the current decade. Since the beginning of 2010, the S&P-500 has gained 85.4%, but the Coca-Cola stock has lagged far behind, rising by just 50% in the same period.
However, Buffett is not going to give up on Coca-Cola. Yes, EPS growth hasn’t been reliable and the company hasn’t always outperformed the broader market. But the profits have been enough for Coca-Cola to consistently reward shareholders through dividends. In fact, Coca-Cola is one of the rare set of companies that have been growing their dividends for the last 50 years (there are only 16 other companies that have managed to achieve this incredible feat). Last month, Coca-Cola raised its dividend for the 54th time in a row.
The chart below compares dividend growth with EPS growth. Clearly, dividend growth has been far more consistent, with annual payouts rising by an average of 9.2% in this period. That’s a big deal for a retail investor who owns, for instance, 1,000 shares of the company. That ownership would have earned the investor an income of $560 in 2005 and this number would have gradually climbed to $1,320 by 2015. For someone like Buffett who owns 400 million shares, this would translate to reliable annual income of hundreds of millions of dollars (roughly $224 million in 2005 and $528 million in 2015).
Note: EPS growth as adjusted. Dividend growth adjusted for stock split
But can Coca-Cola continue going this way for the next 50 years? Of course, no one can answer this question with certainty. But what we can do is take a key investing lesson from Buffett.
Buffett has a knack for ignoring the market’s noise, which may impact a stock’s movement on a short-term basis, and focus on determining its competitive advantage; more importantly, in the words of Buffett “the durability of that advantage.”
For years, Coca-Cola has successfully retained its leadership in the global non-alcoholic carbonated drinks market. Moreover, its market share has grown to 48.5% in 2015 from 45.1% nine years earlier, according to Bloomberg. The company has been so far ahead of its closest rival Pepsico (NYSE:PEP) for so long that it seems unlikely that the competitor is ever going to catch up. In 2015, Pepsi’s share stood at just 20.9%.
It is worth mentioning here that the sale of Coca-Cola’s carbonated beverages which generate nearly 75% of the company’s total sales, including Coke products that represent around 50% of its total sales, have been under pressure from health conscious consumers. Meanwhile, the UK has recently introduced a ‘sugar tax’ on drinks that contain more than five grams of sugar in every 100 millimeters of beverage. This tax, which will be implemented from 2018, could be bad news for the entire beverage industry as it could increase the price of a liter bottle of soda by up to $0.34.
But Coca-Cola is minimizing the health-related risk by focusing on expanding in emerging markets where obesity is not as big an issue as it is in the U.K. or U.S. Moreover, the company is also making major deals, such as its previous investments in Keurig Green Mountain (NASDAQ:GMCR) and Monster Beverage (NASDAQ:MNST), which could offset any negative impact coming from weak organic sales. It is also working on introducing healthier, stevia-sweetened drinks, such as Coca-Cola Life. This and possibly other naturally sweetened, low-calories colas can play a significant role in the company’s portfolio over the long-run. Besides, Coca-Cola has been reporting strong growth in the non-carbonated segment. In the previous quarter, for instance, still or non-carbonated beverages, which include bottled water, juices and ready-to-drink tea, posted strong 6% increase in volumes.
This brings us to an important point. Coca-Cola isn’t just about carbonated drinks. It is also the market leader in the non-carbonated or still beverages space. Overall, Coca-Cola owns an envious portfolio of 20 brands, each of which generates more than $1 billion in annual sales.
Coca-Cola benefits from having decades-old healthy relationships with major retailers, massive bottling and distribution networks and a powerful brand. This not only gives Coca-Cola an opportunity to slowly increase its price but also makes it nearly impossible for any other competitor to take away its market share (sustainable competitive advantage).
Coca-Cola has posted inconsistent EPS growth while its stock hasn’t always beaten the market. But it is a dividend champion that has been regularly growing payouts for the last 54 years. It has been one of the most reliable sources of income for Berkshire Hathaway, as well as its other shareholders. Coca-Cola is well positioned to face its many challenges, including health-related concerns. The company enjoys a sustainable competitive advantage and is well positioned to continue rewarding investors through higher dividends. Coca-Cola will likely be a crucial part of Berkshire Hathaway, and I believe it deserves its place in dividend portfolios of retail investors.