Wednesday, May 22, 2013

Coca-Cola Leads Global Consumer Brand Rankings

According to Kantar Worldpanel, Coca-Cola (KOleads their recent ranking of global fast-moving consumer goods (FMCG) brands:

"Kantar Worldpanel's Brand Footprint Ranking reveals the strength of brands in 32 countries around the world, across the food, beverage, health and beauty and homecare sectors."

Kantar Worldpanel Brand Footprint Report

As I've covered in some (okay, so actually many) prior posts, businesses that sell well-known, trusted, small-ticket consumer goods with great brands and broad-based distribution capabilities tend to also have attractive economic characteristics over the longer run.

Small-ticket consumer goods -- in particular those with excellent brand recognition and substantial distribution strength -- frequently have sustainable competitive advantage, pricing power, and, ultimately, desirable core business economics.

Unfortunately, the stocks of many of the great consumer goods franchises have become, unlike several years ago, at least a bit expensive.

Here are the top five brands according to the report:

Brand                | Company
Coca-Cola        | The Coca-Cola Company
Colgate             | Colgate-Palmolive Company (CL)
Nescafé            | Nestlé (NSRGY)
Pepsi                 | PepsiCo (PEP)
Lifebuoy          | Unilever (UL)

Even though Coca-Cola has the top spot, it is Unilever that has what seems an astonishing 15 of top 50 global brands:

Company                          |Number of Brands in the Top 50
Unilever                            |                  15
Procter & Gamble (PG)|                   8
Coca-Cola                         |                    4
PepsiCo                             |                    5
Nestlé                                 |                    3

So these 5 companies own 70% of the top 50 brands.

Of these companies, all but Coca-Cola's stock comfortably outperformed the S&P 500 over the past 15 years. Check other longer time frames and it becomes obvious that more than solid stock performance among these great franchises is hardly unusual (especially if the initial valuation was not excessive). In fact, though there will always be exceptions, the best among these high quality franchises -- those with the great brands and strong distribution -- have generally done quite well over longer periods of time.

Coca-Cola's underwhelming stock performance is not a reflection of poor business performance. In fact, the business did just fine. It's more a reflection of an extraordinarily high valuation back in 1998. It's as good an example as any that, even for a very high quality business, paying a discount to the current intrinsic value (i.e. not what it might be worth some day), conservatively estimated, matters if an investor wants better than satisfactory investment results at reduced risk.

Occasionally, I'll hear someone argue that the current share price of a particular stock is justified because the future business prospects are unusually good; that it eventually will be intrinsically worth that much some day.

Maybe, but investing is not about whether valuation might be justified (or even more than justified) some day.

It's instead about which well understood investment, among the alternatives, will provide the most attractive returns considering the specific risks.
(What is well understood is necessarily unique to each investor. That's why buying something based upon what someone else thinks is just generally not a good idea. The conviction just won't be there when it counts; when it needs to be.)

It may be, in certain cases, that paying a somewhat higher valuation for a business with clear and sustainable competitive advantages is wise. The reason is simple enough. Those with sustainable advantages will often generate durably high return on capital for long-term owners. In the very long run, it's return on capital that primarily drives value creation and results.*

Return on capital provides a tailwind to the long-term investor (and, if current valuation is misjudged somewhat, it can help dig the investor out of a hole from time to time).

That's no justification for unnecessarily paying premium prices. Even the best business operates in a world of uncertain outcomes, so paying a discount to conservative value in order to protect against what can't be fully known remains a smart practice. The fact that many of these higher quality franchises with the great FMCG brands have done very well in the past guarantee nothing when it comes to the future. The best businesses can still be hurt by unforeseen difficulties -- sometimes serious even if fixable -- from time to time.

As with any business, financial strength as well as competent and honest management with wise capital allocation skills matters. Yet, if looking for businesses that generally have sustainable competitive advantages, companies like the above aren't a bad place to start
(Even if, at this point, it requires the patience to wait for an attractive price to become available in the markets. An investor only has to buy a truly great business at the right price once. After shares of a good business are bought at a fair or better price, it's the intrinsic value created by the business itself that does the heavy lifting when it comes to generating returns. In other words, no unusual trading skills required. In fact, trading likely just adds mistakes and lots of frictional costs.)

So are the best days behind these kinds of businesses? Is it too late? Well, maybe, but consider this:

Some think if an investment idea is well-known and seems obvious it can't be really good. In 1938, Fortune Magazine concluded "Several times every year, a weighty and serious investor looks long and with profound respect at Coca-Cola's record, but comes regretfully to the conclusion that he is looking too late." Since that time, Coca-Cola has grown significantly both domestically and around the world. It was not too late in 1938, and we believe it is far from that today. - From the 1Q 2010 Yacktman Quarterly Letter

To me, the probability that a business like Coca-Cola will perform just fine, even if not quite as well, over a longer future time horizon is not low. Of course, in the short and even medium term, just about anything can happen to share prices.**

Yet, as the short-term "voting machines" gives way to the long-term "weighing machine", share prices will at least roughly track increases to per share intrinsic business value. Well, that value is ultimately driven by business performance. Much as it was not too late for investors to benefit from Coca-Cola's future prospects in 1938, it seems unlikely that it is too late now. Many, if not all the forces, that created these long-term results remain in place.

These are mostly durable high quality businesses -- some, of course, more so than others --that produce high return on capital, at relatively lower risk, especially if bought at the right price.

As I've previously said, what's sensible to buy at a plain discount doesn't make sense at some materially higher valuation no matter how good the business may be.

They have a good probability of continuing to possess competitive advantages but, as always, an investor has to keep an eye on how the economic moat may be changing over time along with capital allocation decision-making by management.

When evaluating the quality of a business, one question worth asking is this: If a business stopped innovating for five years what would happen to its financial performance? Most consumer staples businesses would miss some opportunities, maybe lose some market share, yet would still likely continue to make a nice living and produce at least decent returns.***

Nothing catastrophic.

Not so for most tech stocks. Imagine Apple (AAPL), as good as the company is, not innovating for five years.

Not all so-called "defensive" stocks are created equal. Some of the better ones have more than solid "offensive" characteristics over a true investment time horizon. As I've said before that the reputation for these being defensive stocks isn't incorrect, it's just incomplete. The best of these businesses are not really just defensive, they're higher quality.

Yes, these higher quality stocks usually have less than exciting near-term price action and volatility and are likely to do better in bear markets.
(Though they certainly can drop in price substantially from time to time even if per share intrinsic value does not...I mean, they're still common stocks impacted by the psychology of market participants.)

Yes, they're also likely to not do particularly well in bull markets. Anyone who expects the higher quality stocks to outperform during a bull market is likely to be disappointed. 

That is, in part, how they have earned the reputation of being defensive. Yet, it's when they're looked at over longer time frames (more than a full business cycle or two) that the picture becomes more clear. This may be less exciting, I suppose, but for the long-term investor it should be the overall (full cycle) result and the exposure to relatively less risk that counts.
(Some no doubt attempt to jump in and out of these stocks depending on the market environment. Sounds good in theory but more likely just leads to added frictional costs and expensive errors of omission and commission.)

So these high quality businesses can provide both long-term offense and defense especially if purchased with an appropriate margin of safety in the first place.

Now I suspect one of the reasons why more professional investors do not make full use of, what Jeremy Grantham calls "the one free lunch", is this:


"Smart people aren't exempt from professional disasters from overconfidence. Often, they just run aground in the more difficult voyages they choose, relying on their self-appraisals that they have superior talents and methods." - Charlie Munger in a speech to the Foundation Financial Officers Group

Some seem to think that when a prudent but more straightforward approach comes along there must be more to it. Occasionally, there isn't. When something like that comes along, seems reasonable to considering making some use of it. For many reasons, investing is already inherently difficult enough to do well. No need to make it more so. The difficulties come not just from the need to acquire the necessary investing skills and knowledge, but also from temperamental and psychological factors; from a keen awareness of one's own limits. 

"Warren and I have skills that could easily be taught to other people. One skill is knowing the edge of your own competency. It's not a competency if you don't know the edge of it. And Warren and I are better at tuning out the standard stupidities. We've left a lot of more talented and diligent people in the dust, just by working hard at eliminating standard error." - Charlie Munger in the Stanford Lawyer (Page 19)

Finally, it's worth considering that, too often, those stocks that seemingly provide the prospect of excitement price action and quick gains (i.e. the next big thing or "lottery ticket" stocks that sometimes capture the imagination of market participants) can just as easily produce some big and quick losses. Potential big winners often reside in the same neighborhood as potential big losers and sometimes, at least beforehand, they're difficult to tell apart.

It only takes one big loss to undo a whole bunch of smart investments. Avoiding the material losses while minimizing trading and the related frictional costs is a good place to start.

So is buying everything with a sufficient margin of safety.

When losses and frictional costs get minimized, and shares are consistently bought cheap, it allows the magic of compounding real per share business value over time to be primary driver of long-term returns.

Adam

Established long positions in KO, PEP, PG, and AAPL at much lower than recent market prices

* With any investment, no matter how seemingly attractive, margin of safety is all-important. It protects against the unforeseen real, even if fixable, business problems. Still, it's worth keeping in mind what Charlie Munger said at USC Business School in 1994"If the business earns 6% o­n capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return - even if you originally buy it at a huge discount. Conversely, if a business earns 18% o­n capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result."
So the businesses that can maintain durable and attractive returns on capital have the wind at the back of an investor.
** As always, no views on the price action of marketable stocks are ever offered here. Those who choose speculation on stock price action -- even if informed by fundamentals -- over investment are participating in a very different game. There's nothing wrong with speculation, of course, but it has less in common with investment than some might think. The investment process isn't about price action, it's about what a productive asset can produce with long-term effects mostly in mind. Consider what, in this interview, Warren Buffett had to say"Basically, it's subjective, but in investment attitude you look at the asset itself to produce the return. So if I buy a farm and I expect it to produce $80 an acre for me in terms of its revenue from corn, soybeans etc. and it cost me $600. I'm looking at the return from the farm itself. I'm not looking at the price of the farm every day or every week or every year. On the other hand if I buy a stock and I hope it goes up next week, to me that's pure speculation."
*** In fact, remember what happened when Coca-Cola tried to "innovate" with New Coke?
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