Mohnish Pabrai: Here's Why Buffett Bought Coke (KO) in 1987 | Saber Capital Management 12/09/19, 10(45 PM
Mohnish Pabrai: Hereʼs Why Buffett
Bought Coke (KO) in 1987
John Huber
I was reading a passage from Mohnish Pabrai‘s book Mosaic:
Perspectives on Investing. I love reading Pabraiʼs thoughts and ideas
whenever I can. Heʼs one of the greatest investors of the last 15 years,
establishing a track record that has significantly outperformed the S&P
500, including a remarkable run from 1999-2007 when he averaged
around 30% per year. One reason I like Pabrai is because he uses simple
logic to explain his investment process. Weʼre big fans of simplicity here
at BHI. Another reason I like him is because he is not your typical hedge
fund manager. He never worked on Wall Street, and didnʼt climb the usual
ranks. He started his own business, sold it, and then started his
partnership with $1 million of capital, mostly his own (he now runs about
$500 million). I recommend reading both of his books (Mosaic and the
Dhando Investor).
Pabrai is a huge Warren Buffett follower, and he frequently talks about
how he simply tries to replicate Buffettʼs ideas in his own investing. Study
everything you can on Buffett, reverse engineer his ideas, understand his
theses on his investments, and youʼll learn a lot. In Chapter 13 of Mosaic,
called Latticework, Pabrai explains what he thinks are the five main
reasons why Buffett bought Coca Cola (KO) in the late 80ʼs. There are
many interesting things about that Coke investment by Buffett.
It represented 25% of Berkshire Hathawayʼs book value by the time
Buffett was done buying it
It marked one of the first major investments where Buffett paid much
more relative to earnings and assets than he did for most of his other
investments. Coke was selling around 15 times earnings and I believe
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Mohnish Pabrai: Here's Why Buffett Bought Coke (KO) in 1987 | Saber Capital Management 12/09/19, 10(45 PM
somewhere around 5 times book value at the time.
It was a huge company, one of the largest in America (like it is now).
How does such a large company become so undervalued relative to
its future prospects?? What did Buffett see that the rest of the world
didnʼt at that time?
The investment was a huge success… a “ten-bagger” in Peter
Lynchʼs terminology (Buffett invested $1 billion into Coke that a
decade later was worth around $10 billion)
So it wasnʼt a classic Ben Graham cheap stock-not even close. But it was
a great investment, and it was incredibly undervalued. And we can learn
something by thinking about the logic behind Buffettʼs investment. Notice
that he looked back 80 years (!!!) to learn about Cokeʼs history. Wall
Street looks back a couple quarters and looks ahead a couple quarters
when doing their analysis. That game doesnʼt work well.
Here are five reasons Pabrai gives for why Buffett might have liked Coke:
Buffett is a huge sugar-addict and had been a lifelong passionate
consumer of Pepsi Cola – until 1987. He used to add cherry syrup to
his Pepsi before Cherry Coke was concocted. When he was seven
years old, he used to count the discarded bottle caps around
vending machines and carefully tabulate which drink people were
having the most. He remembers being astounded with the
overwhelming numbers of Coke caps (over 80%) relative to the
numbers for all other drinks.
Buffett is rumored to have a subscription to Advertising Age
magazine. He asked himself what it would cost to replicate the
Coca-Cola brand in a few years. The conclusion Charlie and he
reached was that it probably could not be done – even with $100
billion given to the best marketing team on Earth. At the time, one
could have bought the entire Coca-Cola company for under $20
billion. So, here was a company whose brand alone was worth
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Mohnish Pabrai: Here's Why Buffett Bought Coke (KO) in 1987 | Saber Capital Management 12/09/19, 10(45 PM
well over $100 billion and the entire company could be bought for
under $20 billion.
Buffett pored over the last 80 years of Coca-Cola annual
reports. He found that, like a software company, their gross margin
on their syrup sold to bottlers is well over 80%. Cokeʼs future
success was a function of the number of servings of coke sold
worldwide. The more the servings, the more the cash flow. He found
that over the last 80 years, their syrup volumes sold had risen
every single year. The last 80 years included many ugly world
events – World War I, the great depression, World War II, The Korean
War, The Vietnam War, The Cold War, numerous recessions, being
kicked out of India in the 1970s et cetera. Through all of that, Coke
has grown every single year. The question Munger and Buffett posed
to each other was simple – What volume of syrup might The Coca-
Cola Company conservatively be expected to ship in the year 2000…
2025…2050? They probably came up with some mouth-watering
numbers, then extrapolated free cash flow (about one cent per
eight-ounce serving) and finally arrived at a present value of all that
future cash flow.
In 1886, when Coke was first concocted, it sold for five cents per
eight-ounce serving. Today, one can buy eight ounces of Coke on
sale for under 17 cents. If Cokeʼs pricing had moved in lockstep with
inflation, weʼd be paying several dollars for a single can. This is a
very unusual product whose unit price has declined dramatically
over the years. Very few consumer products have demonstrated the
level of decline in prices that Coke has over the last century.
Billions of people around the world have yet to have their first Coke.
In addition, the daily per capita consumption of bottled beverages
around the world is miniscule compared to that of the United States
and Europe. However, it has risen dramatically in various countries
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Mohnish Pabrai: Here's Why Buffett Bought Coke (KO) in 1987 | Saber Capital Management 12/09/19, 10(45 PM
as per capita incomes have risen. We are likely to see big increases
in per capita incomes in the third world over the coming decades.
The typical hammer-wielding Wall Street analyst is fixated on the next
few quarters, not the next half century when trying to figure out any
given company. No Wall Street analystʼs mental model of Coke in 1988
was comprised of the latticework that Munger and Buffett fixated upon.
Individual investors will do well if they only made investments within their
circle of competence based on an independent latticework of mental
models. When all your mental models all converge at about the same
intrinsic value for a given business, and that value is well above the price
of the business, back up the truck.
Makes me want to head over to Food Lion and grab some Cherry Coke
for the evening. Have a great weekend!
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