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T H E W A R R E N B U F F E T T W AY
Coca-Cola
From the time that Roberto Goizueta
took control of Coca-Cola in
1980, the company’s stock price had increased every year. In the f ive
years before Buffett purchased his f irst shares, the price increased an av-
erage of 18 percent every year. The company’s fortunes were so good
that Buffett was unable to purchase any shares at distressed prices. Still,
he charged ahead. Price, he reminds us, has nothing to do with value.
In June 1988, the price of Coca-Cola was approximately $10 per
share (split-adjusted). Over the next ten months,
Buffett acquired
93,400,000 shares, at an average price of $10.96—fifteen times earnings,
twelve times cash f low, and five times book value. He was willing to do
that because of Coke’s extraordinary level of economic goodwill, and be-
cause he believed the company’s
intrinsic
value was much higher.
The stock market’s value of Coca-Cola in 1988 and 1989, during
Buffett’s
purchase period, averaged $15.1 billion. But Buffett was con-
vinced its intrinsic value was higher—$20 billion (assuming 5 percent
growth), $32 billion (assuming 10 percent growth), $38 billion (at 12
percent growth), perhaps even $48 billion (if 15 percent growth). There-
fore Buffett’s margin of safety—the discount to intrinsic value—could
be as low as a conservative 27 percent or as high as 70 percent. At the
divided by [10 minus 3 percent]). So the $223 million purchase
price represented a very good value. Also, Buffett was con-
vinced the fundamental economics
of the company were sound,
and that the lower numbers were a short-term response to the
depressed economy at the time.
As is so often the case, Larson-Juhl approached Berkshire,
not the other way around. Buffett describes the conversation:
“Though I had never heard of Larson-Juhl before Craig’s call, a
few minutes talk with him made me think we would strike a
deal. He was straightforward in describing the business, cared
about who bought it, and was realistic as to price.
Two days
later, Craig and Steve McKenzie, his CEO, came to Omaha and
in ninety minutes we reached an agreement.”
12
From first con-
tact to signed contract, the deal took just twelve days.
I n v e s t i n g G u i d e l i n e s : V a l u e Te n e t s
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same time, his conviction about the company had not changed: The
probabilities of Coca-Cola’s share price beating the market rate of return
were going up, up, and up (see Figure 8.1)
So what did Buffett do? Between 1988 and 1989,
Berkshire Hath-
away purchased more than $1 billion of Coca-Cola stock, representing
35 percent of Berkshire’s common stock portfolio. It was a bold move.
It was Buffett acting on one of his guiding principles: When the proba-
bilities of success are very high, make a big bet.
Gillette
From 1984 through 1990, the average annual gain in Gillette’s share
was 27 percent. In 1989, the share price gained 48 percent and in 1990,
the year before Berkshire converted its preferred stock to common,
Gillette’s share price rose 28 percent (see Figure 8.2). In February
1991, Gillette’s share price reached $73 per share (presplit), then a
record high. At that time, the company had 97
million shares outstand-
ing. When Berkshire converted, total shares increased to 109 million.
Gillette’s stock market value was $8.03 billion.
Depending on your growth assumptions for Gillette, at the time of
conversion the market price for the company was at a 50 percent discount
Figure 8.1
Common stock price of the Coca-Cola Company compared to the S&P 500
Index (indexed to $100 at start date).
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T H E W A R R E N B U F F E T T W AY
to value (15 percent growth in owner earnings), a 37 percent discount
(12 percent growth), or a 25 percent discount (10 percent growth).
The
Washington Post Company
Even the most conservative calculation of value indicates that Buffett
bought the Washington Post Company for at least half of its intrinsic
value. He maintains that he bought the company at less than one-
quarter of its value. Either way, Buffett satisf ied Ben Graham’s premise
that buying at a discount creates a margin of safety.
The Pampered Chef
It is reported that Buffett bought a majority
stake in the Pampered Chef
for somewhere between $800,000 and $900,000. With pretax margins
of 20 to 25 percent, this means that the Pampered Chef was bought at a
multiple of 4.3 times to 5 times pretax income and 6.5 times to 7.5
times net income, assuming full taxable earnings.
With revenue growth of 25 percent or above and net income that
converts into cash at anywhere from a high fraction of earnings to a
multiple of earnings, and with a very high return on capital, there is no
doubt that the Pampered Chef was purchased at a signif icant discount.
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