Thursday, May 26, 2022

How to turn $40 into $21 million

Coca-Cola (KO) is a dividend king, which has managed to increase dividends to shareholders for 57 years in a row. The company has paid dividends for 100 years. It is a widely-owned company, and a favorite for many dividend investors.

In 1919, Coca-Cola had its IPO. The stock sold at $40/share to investors and had a yield of 5%.
By 1920, the stock had declined by 50% on fears that sugar prices were going up. Investors saw unrealized losses and a gloomy near terms picture.

As we all know, Coca-Cola ultimately became a dominant blue chip company. But that wasn’t so evident in 1920.

As Ben Graham said: "In the short-run, the market is a voting machine - reflecting a voter-registration test that requires only money, not intelligence or emotional stability - but in the long-run, the market is a weighing machine."

Those $40 invested in 1919 turned into a little over $21 million a century later with dividend reinvestment. This investment would be paying almost $600,000 in annual dividend income.

This is the result of a long-term compounding at a high rate of return over long periods of time. It is basic math.

Getting those returns was not easy however. There were obstacles along the way, which would have easily convinced any investor that the best days for Coca-Cola were behind it.

Back in 1938 for example, Fortune Magazine warned investors that the best days for Coca-Cola are already behind it: "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. The specters of saturation and competition rise before him."

If you look at the stock price chart however, it looks like there were several long periods, which didn't offer much in terms of returns:

1938 – 1959
1972 – 1985
1998 – 2011

It is very likely that investors were questioning their choices, given the stagnant share price for extended periods of time. There was always some fear that the best days are behind Coca-Cola. Yet, after forming a long base, and exhausting impatient stockholders into selling, Coca-Cola reinvigorated itself and became a Wall Street darling one more time.

Patient dividend investors who were satisfied with the stability of the product demand, and the stability of their dividend checks kept holding onto the stock through thick and thin. When you are getting paid to own a stock, it is much easier to ignore where the stock price goes. It is also easier to ignore negative news about a company, which surely come after share prices have gone nowhere for a long period of time or after they have declined. Buying a stock for its dividend is the ultimate edge that gives dividend investors the patience to endure challenging conditions such as the long periods of time where prices went nowhere. Receiving a dividend is a reminder that you are a part owner of a real business, which provides an economic purpose to others. As a result, you receive your proportional share of the profits in the form of cold hard cash.

I have found quite a few stories about successful Coca-Cola shareholders, who held on for decades. Their descendants held on for decades as well. Those smart and patient enough to invest in Coca-Cola 100 years ago have managed to provide for their families for several generations.

As I mentioned above, a $40 investment turned into $21 million with dividend reinvestment. The portfolio would be generating over half a million dollars in annual dividend income, which is twelve times the median income for a worker in the United States today. This is all coming from a $40 investment that compounded for a century. These $40 from 1919 had the same purchasing power of roughly $600 today.

If you and your trust fund kids and grandkids had simply lived off the dividend income during the past century however, you would have still done well.

For example, one of SunTrust’s predecessor companies was paid $100,000 in Coca-Cola stock for its work on its IPO in 1919. The bank kept the stock, and cashed in those dividends for over 90 years, before finally selling in 2012 for a tidy sum of $2 billion. Had they waited for seven more years, they could have doubled their money to $4 billion, but who is counting?

I received a lot of pushback when I originally posted the results of that fateful $40 investment in Coca-Cola in 1919, turning into $21 million with dividends reinvested. The common response to “ if you had invested in Coca-Cola in 1919..” was that you would be dead by now.

That is a very shortsighted response, because it ignores the realities of financial planning. In general, if you and your spouse are in your 20s or 30s, you could realistically have a 60 – 70 year period to plan for. This includes the lifetimes for you and your spouse only, as it is quite possible that at least one of these partners will make it for a longer time than the other. If you have children in your 20s or 30s, it is quite possible that you are looking at a 70 – 80 or even 90 year period for planning. If you want to create a sort of generational wealth that covers a few generations after you, and you have sufficient means, you can always set up a trust fund that can serve your goals in a way that you want them accomplished. While I would not put everything in one stock for a trust fund, I would have principal be held and just dividends be distributed to beneficiaries. Long-term planning is beyond the scope of this article, but if this concerns you, you should speak with a licensed professional who can set things up for you ( for a reasonable fee).

The long-term returns of the original investment in Coca-Cola has been widely publicized of course.
Warren Buffet has invested heavily into Coca-Cola, and has been an investor for over 30 years now. Between 1988 and 1994, Berkshire Hathaway acquired 400 million shares of Coca-Cola for $1.3 billion. He has a split-adjusted cost of $3.25/share. Coca-Cola has an annual dividend of $1.76/share.

The company will distribute $704 million in annual dividends to Berkshire in 2022. That means every two years, Buffett gets his cost basis back, while retaining ownership of the stock. That’s a nice yield on cost of 50%. The dividend is also a tax advantaged way for Berkshire Hathaway to recognize profits, and is more tax advantaged than capital gains. That's why Warren Buffett prefers dividends over capital gains.

Warren Buffett spoke extensively about it in his 1993 letter to shareholders:

Earlier I mentioned the financial results that could have been achieved by investing $40 in The Coca-Cola Co. in 1919. In 1938, more than 50 years after the introduction of Coke, and long after the drink was firmly established as an American icon, Fortune did an excellent story on the company. In the second paragraph the writer reported: "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. The specters of saturation and competition rise before him."

Yes, competition there was in 1938 and in 1993 as well. But it's worth noting that in 1938 The Coca-Cola Co. sold 207 million cases of soft drinks (if its gallonage then is converted into the 192-ounce cases used for measurement today) and in 1993 it sold about 10.7 billion cases, a 50-fold increase in physical volume from a company that in 1938 was already dominant in its very major industry. Nor was the party over in 1938 for an investor: Though the $40 invested in 1919 in one share had (with dividends reinvested) turned into $3,277 by the end of 1938, a fresh $40 then invested in Coca-Cola stock would have grown to $25,000 by yearend 1993.

I can't resist one more quote from that 1938 Fortune story: "It would be hard to name any company comparable in size to Coca- Cola and selling, as Coca-Cola does, an unchanged product that can point to a ten-year record anything like Coca-Cola's." In the 55 years that have since passed, Coke's product line has broadened somewhat, but it's remarkable how well that description still fits.
Charlie and I decided long ago that in an investment lifetime it's just too hard to make hundreds of smart decisions. That judgment became ever more compelling as Berkshire's capital mushroomed and the universe of investments that could significantly affect our results shrank dramatically. Therefore, we adopted a strategy that required our being smart - and not too smart at that - only a very few times. Indeed, we'll now settle for one good idea a year.

He also discussed it in a speech from the late 1990s. The video is titled “how to turn $40 into $5 million”. Source: Youtube

Even Coca-Cola itself posted a press release in 2012 that a $40 investment in 1919 would have turned into $9.80 million 93 years later. Those figures assume dividend reinvestment. Source: Coca-Cola Press Release

Today, the future for Coca-Cola looks bleak again. The company is at the crossroads, as sugary drinks consumption is declining, and people are supposedly becoming more health conscious. However, there is a bright spot for international expansion in developing markets. The share price is only marginally higher than the highs reached in 1998. At the time, the stock price was overvalued, while today it is still richly valued though not as high as 20 years ago.

Coca-Cola and many other great consumer franchises became extremely expensive in the late 1990s. At that time they could not be bought at prices that would produce a satisfactory return. Market prices for these stocks were materially higher than intrinsic value. The lost decade ending in 2009 has managed to correct that. As you can see, prices tend to overshoot on the upside, as in 1972 and 1998, and overshoot on the downside (as in 1999 – 2009).

It remains to be seen whether the best days of Coca-Cola are behind it, or whether it would stage another massive comeback. We won’t know for the next twenty years unfortunately. I do believe that a patient holder of Coca-Cola stock will probably do ok over the next 20 years for as long as the dividend is maintained and not cut. If the dividend is cut, I would be selling my shares one second after the announcement, because it would prove to me that my thesis and initial argument to buy and hold the stock was invalid.

Relevant Articles:

Coca-Cola (KO) Dividend Stock Analysis
How Warren Buffett earns $1,140 in dividend income per minute
This Is Why Warren Buffett Prefers Dividends Over Capital Gains
Investors Get Paid for Holding Dividend Stocks

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