Good Deal: Berkshire Hathaways's purchase of Coca-Cola (1988)
Good Deal, Bad Deal

In a lifetime of successful investing, this was Warren Buffett's most profitable investment.

What went right:
Even though Warren Buffett has been known for his conservative investment philosophy, he has been willing to change (some) with the times, expanding his definition of value to include intangible, yet real, assets such as brand awareness and management acumen. In targeting Coca-Cola, he picked a stock that was overvalued by his traditional standards, but which profited Berkshire Hathaway more than $10 billion.

Warren Buffett is the most successful investor in history. Even with the price of his investment company, Berkshire Hathaway, slumping for two years, a $10,000 investment in Berkshire when Buffett took it over in 1965 would be worth $50 million in 2000.

Buffett owes his success to value investing, a doctrine most eloquently espoused by Benjamin Graham, a professor of Buffett's at Columbia in the 1930s, and author (with David Todd) of Security Analysis.

According to Graham, stocks have an intrinsic value based on their asset values, separate from the stock market's valuation. The analysis is rigid and technical, requiring investment only in stocks selling at discounts to book value.

Buffett admits that Graham would not have bought Berkshire Hathaway in recent years, nor would he have bought any of the stocks Buffett has bought. Buffett has gone beyond Graham's definition of value investing. He has learned about definitions of "value," and, with all the investments Buffett has had to make, especially in the predominantly rising market of the last 20 years, he has had to expand his definitions a bit.

It was in this process that Buffett made his greatest investment: purchases on the open market of $1 billion in Coca-Cola stock in 1988 and 1989. Coca-Cola could not possibly meet Graham's concept of a value investment, selling at a large premium to book value. (For example, the company carries its trademarks at no or nominal value, and those trademarks are generally regarded as the company's most valuable assets.)

During 1988, Buffett began buying Coca-Cola stock. Trying to keep news of his purchases from driving up the price, he began buying after Berkshire's annual meeting and continued through the summer. (Because Buffett was renowned as an investor, people often assume that if he's buying, they should be buying, too.) By the time Berkshire was required to disclose the purchases, it had bought more than 176 million shares (adjusted for four subsequent stock splits), or 6.3 percent of the company, for just more than $1 billion. Buffett spent another $200 million to raise the stake to 200 million shares during 1994.

For obvious strategic reasons, Buffett generally discloses his investments and philosophy only as the law requires or when it suits his purposes. He likes the image of simpleton and is happy if people accept his initial explanation that he made the purchases because of his fondness for Cherry Coke. On other occasions, however, he has given some of his reasons, and they are consistent with many of his stock purchases of the last two decades.

Buffett had a high regard for Coca-Cola's management and its deployment of assets. Coke's COO, Don Keough, was an old acquaintance of Buffett's from Omaha, and Buffett had a great respect for his abilities. Buffett also admired CEO Roberto Guizueta, who reversed the company's conglomerization (including the moves Guizueta himself instituted), focusing solely on building and exploiting Coca-Cola's brand awareness around the world.

Most important, Coca-Cola's brand name was an asset, according to Buffett, of phenomenal value. The most recognized brand name in the world, it simultaneously (if managed properly) assured premium prices and fought off competitors. Even though 80 percent of Coca-Cola's business is outside the U.S., there are huge portions of the world still to conquer. With its brand awareness, its management, and its experience in winning over foreign markets, there was enormous value in those untapped markets.

In a lifetime of successful investing, this was Buffett's most profitable investment. In less than three years, the price of Coca-Cola stock doubled. The next year, in Berkshire's 1991 annual report, Buffett noted that "[w]hen we loaded up on Coke three years ago, Berkshire's net worth was $3.4 billion' now our Coke stock alone is worth more than that."

After a couple slow years, the stock price started accelerating again. The investment gained $1 billion in 1994, another $2.5 billion in 1995, and yet another $2.5 billion in 1996. Even though Coca-Cola has slumped in the stock market from 1998 through early 2000, in August 200, Berkshire's $1.3 billion investment was worth more than $12 billion.

Michael Craig

4/18/07

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