Friday, July 9, 2010

Altria vs Coca-Cola

A decade ago the S&P 500 index was at 1,475.

Today, after a nice rally this week it sits at 1,070 so any investor that matched the performance of the S&P 500 index (including dividends) is down substantially in the past ten years.

Of course, most investors do not even match the index...never mind outperform it.

Ten years ago, many sectors were overvalued...not just tech stocks. Coca-Cola (KO) was selling at a PE over 40. In fact, most of the great franchises like Coca-Cola were overvalued at that time. They (the likes of PG, PEP, JNJ and many others) spent the past decade increasing intrinsic values enough to "catch up" to their stock prices. All these businesses produce durable high returns on capital but they were not cheap enough to gain much benefit as an investor. The good news is they have, by and large, "caught up" as most sell for PE's less than 15 with some much lower than that.

One of the exceptions to the widespread overvaluation that existed ten year ago was Altria (MO). If you bought Altria back then the 10 year return, as of today, is over 540% including dividends. The reason is simple. Altria was both cheap and produces high returns on capital. Keep in mind, it accomplished this without the expansion of its PE to some nonsensical level. Today, Altria sells for around 11-12x earnings.

In contrast, while Coca-Cola's stock still outperformed the S&P 500, it didn't make you much money. Intrinsically, the business of Coca-Cola went up in value substantially over the past decade but it's just that the price ten years ago just about fully reflected today's value.

Altria didn't have a better decade in terms of business performance than Coca-Cola. The stock performance comes down to Altria was selling well below intrinsic value while Coca-Cola was definitely not.

Coca-Cola currently sells for 14-15x earnings so, unlike last decade, the odds are much better that the stock performance will come close to matching growth in intrinsic value going forward.

Adam

Long positions in all stocks mentioned

Related post:
GM vs Philip Morris (Altria)
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