Wednesday, April 17, 2013

Coca-Cola's 1st Quarter 2013 Results

From Coca-Cola's (KO) latest earnings release:

The Coca-Cola Company reported worldwide volume growth of 4% for the first quarter, with 3% growth in Coca-Cola Americas and 5% growth in Coca-Cola International. The Company reported solid volume growth in key developed markets, including Germany (+3%), North America (+1%) and Japan (+1%). Europe volume was even for the first quarter and a sequential improvement from fourth quarter 2012, despite ongoing uncertain macroeconomic conditions and unseasonably cold weather. The Company also delivered strong volume growth during the quarter in key emerging markets, including Thailand (+18%), India (+8%), Russia (+8%), Mexico (+3%) and Brazil (+3%).

On the surface, it was not exactly a spectacular quarter.

Net revenues and operating income were actually down 1% and 4% respectively.

Oh, and the already at least seemingly somewhat pricey stock -- roughly 20x current earnings -- has traded even higher since these results were released.

I'll let others try to figure out or justify why this is.*

Let's step back a bit from these near-term results.

In prior posts, I've looked at how the earnings of certain companies (including KO) were impacted by the financial crisis. A business that can do okay during the tougher times seems likely to do just fine when some of the storms have passed over the longer haul (i.e. not quarter-to-quarter or even year-over-year). To me, understanding a company's economic resilience is at least as important, if not more important, than understanding the potential upside. The gains usually takes care of themselves if an appropriate price is paid in the first place, the core economics are attractive, durable, and, of course, were judged reasonably well.

Before the financial crisis, Coca-Cola had peak earnings of $ 1.28 per share. Those earnings dropped somewhat to $ 1.24 per share in 2008 -- its worst year during the crisis. That was followed by earnings of $ 1.46 per share in 2009.

If nothing else quite persistent even if explosive growth is just about never in the cards for a business like Coca-Cola.

Five years later or so, the company seems likely to earn $ 2.10-2.20 per share.

So roughly 65-70% higher in five years.

Coca-Cola has, in recent years, delivered solid increases to its per share intrinsic value with little drama. Who knows if the company will do quite as well going forward, but it has certainly become a lot tougher to buy at a discount to its current approximate value. The same thing happens to be true for many other high quality businesses. They're still good businesses but price paid relative to value, as always, is all-important:

"Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk. Indeed, when great uncertainty – such as in the fall of 2008 – drives securities prices to especially low levels, they often become less risky investments." - Seth Klarman in his 2010 Annual Letter

I think it is fair to say that the idea that more risk must be taken to achieve greater rewards is a rather widespread one. It certainly gets stated often enough without challenge as if a given. Well, it's not necessarily wrong, it's just an incomplete view of the world. As Warren Buffett explains further here, risk and reward does not have to be positively correlated (and the reason isn't at all complicated or tough to understand).

So some might choose to assume risk and reward are always positively correlated. In many instances they are, of course. Just not always. A lower price both reduces risk and increases potential reward. A simple insight, yes, but not at all unimportant.

Negative correlation.

Occasionally, simple but useful insights get overlooked because an assumption is made that there's more to it.

This seems a good candidate for that sort of thing.

It's not difficult -- especially during a chaotic time like a financial crisis -- to find reasons NOT to buy something. Scary headlines, dire forecasts, loss aversion, and raw emotions (among other things) provide plenty of distractions away from simply comparing prevailing prices to conservatively estimated value then, when a discount is plain, acting accordingly.

The time buy shares of a good business at a nice discount to value is rarely going to be when it feels safe. Usually it's when confidence is low and it seems the most uncertain that attractive prices become available.

I say seems because the world is always uncertain. It just seems more uncertain at different times.

"The world's always uncertain. The world was uncertain on December 6th, 1941, we just didn't know it. The world was uncertain on October 18th, 1987, you know, we just didn't know it. The world was uncertain on September 10th, 2001, we just didn't know it." - Warren Buffett on CNBC

It's impossible to know when the window of opportunity to buy a meaningful amount something sensible at a discount will close.

"We try to avoid buying a little of this or that when we are only lukewarm about the business or its price. When we are convinced as to attractiveness, we believe in buying worthwhile amounts." - From the 1978 Berkshire Hathaway Shareholder Letter

It was comparably easier to buy shares of the higher quality businesses not too long ago but it wasn't when it felt comfortable. It was when the macro environment felt pretty awful and at least temporary paper losses -- and maybe even permanent losses if value were to get misjudged -- were very likely.

Mistakes are easy to make in chaotic environment.

When it didn't feel good is when the big discounts were available (fewer opportunities now but naturally not none). That's likely to be true in the future. The problem isn't necessarily knowing what's selling cheap and should be bought. The problem is more temperamental; it's aspects of human nature itself.

In contrast to several years back (and even more recently), the window of opportunity to buy at truly bargain prices has mostly closed for the highest quality businesses.**

At least it has for now.

Naturally, there's always something that's individually mispriced but only so many things can be well enough understood. Those buying now instead of buying when confidence was lower and uncertainty seemed greater are taking far more risk and likely to get far worse long-term results.

More risk for less reward. Also, lacking an appropriate margin of safety, greater likelihood of permanent capital loss.

Buying the best assets cheap is easier (though not easy) during a rough patch. Many good assets are far harder to buy right now at a price that minimizes the risk of permanent losses. It might feel safer but, at least somewhat paradoxically, that's the reason it is likely not.

Others can try to speculate on price action but, as far as true investment goes, it's an inherently tougher environment simply because prices are higher.


Long position in KO established at much lower than recent prices

* All I know is, as a long-term owner, I'd prefer that the shares get cheaper in the near-term or even longer. When prices drop further below intrinsic value, the buybacks are more effective and more shares can be accumulated at a discount over time. As always, I never have an opinion or any idea what the near-term price action of individual stocks or the markets in general might be. The good news it is not a required skill in investment (though for those involved in speculation on price action, I suppose it is). Instead, I'm interested in how price compares to per share intrinsic value -- or, at least, a likely range of intrinsic values; I'm interested in how intrinsic value is likely to change over time; I'm also interested in getting better, over time, at judging intrinsic value in the first place. Those things are all difficult enough to do consistently well without -- at least in my case -- lots of work. 

Any attempt at picking bottoms or guessing what prices might do short-term would be a waste of energy for me. I suspect it is for many others but no doubt someone does that sort of thing well.
** That doesn't mean I'll sell the shares of high quality businesses because they're fully valued or maybe even somewhat more than fully valued. Once a good business that's understood well is owned at a discount, my view is it's better to hold on unless price relative valuation gets extreme, something fundamentally has damaged the business economics, intrinsic value was misjudged in the first place, or the opportunity costs are high. The merits of this approach are not insignificant but I understand why few utilize it.
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