Coca Cola's intrinsic value when Buffett first purchased it in 1988.

Buffett first purchased Coca-Cola in 1988.  In 1988:

• Owner earnings (net cash flow) of Coca-Cola = $828 million.
• Risk free rate of 30 year US Treasury Bond = 9% yield.

Discounted value of Coca-Cola's current owner earnings.

If Coca-Cola's 1988 owner earnings were discounted by 9% (Buffett does not add an equity risk premium to the discount rate):

• the value of Coca-Cola would have been $828m/9% = $9.2 billion.

$9.2 billion represents the discounted value of Coca-Cola's current owner earnings.




Was Buffett paying too much for Coca-Cola?


When Buffett purchased Coca-Cola, the market value of the company was $14.8 billion, indicating that Buffett might have overpaid for the company.

Because the market was willing to pay a price for Coca-Cola that was 60% higher than $9.2 billion, it indicated that buyers perceived part of the value of Coca Cola to be its future growth opportunities.

People asked, "Where is the value in Coke?"

The company's price was
- 15x earnings (30% premium to the market average), and,
- 12x cash flow (50% premium to the market average).




Where is the value in Coke? Its net cash flows discounted at an appropriate interest rate.


Buffett first purchased Coca-Cola in 1988.

Buffett paid 5x book value for a company with a 6.6% earning yield.

The company was earning a 31% ROE while employing relatively little in capital investment.

The value of Coca-Cola, like any other company, is determined by the net cash flows expected to occur over the life of the business, discounted at an appropriate interest rate.

When a company is able to grow owner earnings without the need for additional capital, it is appropriate to discount owner earnings by the difference between the risk-free rate of return (k) and the expected growth (g) of owner earnings, that is (k-g).




Using a two-stage discount model

Analyzing Coca-Cola, we find that owner earnings from 1981 through 1988 grew at 17.8% annual rate - faster than the risk-free rate of return.

When this occurs, analysts use a two-stage discount model.  

• This model is a way of calculating future earnings when a company has extraordinary growth for a limited number of years, and 
• then a period of constant growth at a slower rate.

We use this two-stage process to calculate the 1988 present value of the company's future cash flows.

In 1988, Coca-Cola's owner earnings were $828 million.

If we assume that Coca-Cola would be able to grow owner earnings at 15% per year for the next 10 years (a reasonable assumption, since that rate is lower than the company's previous seven-year average), by year 10, owner earnings will equal $3.349 billion.

Let us further assume that starting in year 11, growth rate will slow to 5% a year.  Using a discount rate of 9% (the long term bond rate at the time), we can calculate that the intrinsic value of Coca-Cola in 1988 was $48.3777 billion. 

(see Appendix A below for the detailed calculations.)




Using different growth-rate assumptions

We can repeat this exercise using different growth-rate assumptions.

• If we assume that Coca-Cola can grow owner earnings at 12% for 10 years followed by 5% growth, the present value of the company discounted at 9% would be $38.163 billion.
• At 10% growth for 10 years and 5 % thereafter, the value of Coca-Cola would be $32.497 billion.
• And if we assume only 5% throughout, the company would still be worth at least $20.7 billion [$828 million divided by (9% - 5%)].

Market price has nothing to do with value

The stock market's value of Coca-Cola in 1988 and 1989, during Buffett's purchase period, averaged $15.1 billion.

But by Buffett's estimation, the intrinsic value of Coca-Cola was anywhere from

• $20.7 billion (assuming 5% growth in owner earnings), 
• $32.4 billion (assuming 10% growth), 
• $38.1 billion (assuming 12% growth), 
• $48.3 billion (assuming 15% growth).

So Buffett's margin of safety - the discount to intrinsic value - could be as low as a conservative 27% or as high as 70%.




"Value" investors using P/E, P/B and P/CF considered Coca-Cola overvalued and missed purchasing it.

"Value" investors observed the same Coca-Cola that Buffett purchased and because its price to earnings, price to book, and price to cash flow were all so high, considered Coca-Cola overvalued.





===========

Appendix A: 

The Coca-Cola Company Discounted Owner Earnings Using a Two-Stage "Dividend" Discount Model (first stage is 10 years)

First stage:
Owner Earnings in 1988  $828 m
Growth rate 15% for next 10 years
Discount factor 9%

Sum of present value of owner earnings   = $11,248 
(Year 1 to 10)


Second stage:
Residual Value or Terminal Value

Owner earnings in year 10  $3,349
Growth rate (g)  5%
Owner earnings in year 11   $3,516
Capitalization rate (k-g)  4%
Value at end of year 10   $87,900
Discount factor at end of year 10  0.4224

Present Value of Residual                           =  $37,129


Intrinsic Value
Intrinsic Value of Company                        =  $48,377


Notes: 
Assumed first-stage growth rate = 15%
Assumed second-stage growth rate = 5%
k = discount rate = 9%
Dollar amounts are in millions.



Descriptive step-by-step approach to the above DCF:

The first stage applies 15% annual growth for 10 years. 

In year one, 1989, owner earnings would equal $952 million; by year ten, they will be $3,349 billion.

Starting with year eleven, growth will slow to 5% per year, the second stage.

In year eleven, owner earnings will equal $3,516 billion ($3,349 billion x 5% + $3,349 billion).

Now we can subtract this 5% growth rate from the risk-free rate of return (9%) and reach a capitalization rate of 4%.

The discounted value of a company with $3,516 billion in owner earnings capitalized at 4% is $87.9 billion.

Since this value, $87.9 billion, is the discounted value of Coca-Cola-s owner earnings in year eleven, we next have to discount this future value by the discount factor at the end of year ten  1/(1 + 0.09)^10 = 0.4224. 

The present value of the residual value of Coca-Cola in year ten is $37.129 billion. 

The value of Coca-Cola then equals its residual value ($37.129 billion) plus the sum of the present value of cash flows during this period ($11.248 billion), for a total of $48.377 billion.

The Coca-Cola Company

The Coca-Cola Company

KO (NYSE)

Website:  www.coca-cola.com

Sector:  Consumer Staples
Beta Coefficient: 0.49
10 Yr Compound EPS Growth:  8%
10 Yr Compound DPS Growth   9.5%

Dividend raises, last 10 years: 10 times.


Financial Result Year 2014

Revenues (m)   45,998
Net Income (m)   9,091
EPS  2.04
DPS 1.22
Cash flow per share 2.53
Current yield 3.2%

High Price  45.0  P/E 22.1   DY 2.71%
Low Price  36.9  P/E 18.1   DY  3.31%


The Coca-Cola Company is the world's largest beverage company.  

For more than 100 years, the company has mainly produced concentrates and syrups, which it then bottles or cans itself or sells to independent bottlers worldwide.  

It took a big step to own the supply chain in 2010 with the acquisition of bottler Coca-Cola Enterprises" North Amercian operations; CCE still handles distribution for Europe.

Independent bottlers add water ingredients, then bottle and distribute the products to restaurants, retailers and other distributors.  

The company owns the brand and is responsible for consumer brand marketing initiatives, while the distributors handle all downstream merchandising.

The company operates in more than 200 countries and markets nearly 500 brands of concentrate and finished beverages.

In terms of unit case volume, 79% of all sales are overseas - 29% in Latin America, 15% in Eurasia/Africa, 21% in the Pacific and 14% in Europe.

In terms of revenues, the company counts about 57% as overseas sales.

With $18 billion in cash in hand, Coke has made many strategic acquisitions.  Coke has the means.

Cash returns to investors are decent on both the buyback and dividend front, with high single-digit to 10% dividend raises the norm, even with flat performance.

For a company this size, it still make 20% net profit margin.  

Warren Buffett said he'll never sell a single one of the 400 million shares of Coke stock he owns.  "I like to bet on sure things."

Coke has category leadership, especially, in soft drinks, juices and juice drinks, and ready to drink coffees and teas.

They are number two globally in sports drinks and number three in packaged water and energy drinks.  

In Coca Cola, Diet Coke, Sprite and Fanta, they own four of the top five brands of soft drink in the world.

The Coca Cola name is probably the most recognized brand in the world and is almost beyond valuation.

The company have raised dividends in each of the past 53 years, and returned some $8.5 billion out of $10.5 billion in cash generated to shareholders in 2013.

Dividend raises, last 10 years: 10 times.

It is also a pure play on international business as you will find in a US company.

The low beta of 0.49 continues to confirm its low-volatility credentials.

This is a slow, steady growth story, which may be too slow for many, with new risks the company didn't face when Mr. Buffett bought in years ago.

Buffett's $2 Billion Mistake

Uniquely, Buffett also considers what could have been when he analyzes his mistakes.

In 1988 he wanted to buy 30 million (split-adjusted) shares in Federal National Mortgage Association (Fannie Mae), which would have cost around $350 million.

"After we bought about 7 million shares, the price began to climb.  In frustration, I stopped buying ...  In an even sillier move, I surrendered to my distaste for holding small positions and sold the 7 million shares we owned."

In October 1993, he told Forbes that "he left $2 billion on the table by selling Fannie Mae too early.  He bought too little and sold too early.  "It was easy to analyze.  It was within my circle of competence.  And for one reason or another, I quit.  I wish I could give you a good answer."

This was a mistake that, he wrote, "thankfully, I did not repeat when Coca-Cola stock rose similarly during our purchase program which began later the same year.

Warren Buffett on Pepsi

Very few people have gotten rich on their 7th best idea. You'd be much better off putting more money into your best idea.

Warren Buffett:

"There are a lot of things you can learn if you are around securities over the course of your career, and you will find a lot of arbitrage opportunities. However, that probably won't be the primary driver of your investment returns.

If you are not a professional investor, then you should be extremely diversified and you should do very little trading. However, if you want to bring an intensity to the game, and you are going to value businesses, then diversification is a terrible mistake. If you really know business, then you shouldn't own more than 6 businesses. Very few people have gotten rich on their 7th best idea. You'd be much better off putting more money into your best idea. "

How to Profit From the Great Greek Bankruptcy of 2012

Don't play a starring role in this big, fat Greek tragedy

So how can investors position themselves to profit from all this, if events play out according to plan? First and foremost: with patience. The Athens Stock Exchange Index has fallen far already -- down about 63% over the past year. But Russia's RTS took a pounding prior to its default, too, and that didn't save it from sliding further post-default.

The low P/E ratios on stocks like National Bank of Greece (NYSE: NBG  ) or Coca-Cola Hellenic Bottling (NYSE: CCH  ) may tempt investors today, but have no doubt: They could get even cheaper in the event of an official exit from the euro. A "Grexit" could likewise spark selling of foreign-listed but Athens-based shipping companies such as DryShips(Nasdaq: DRYS  ) , Diana Shipping (NYSE: DSX  ) , and Excel Maritime (NYSE: EXM  ) .

Long story short, there will be a time to profit from the great Greek bankruptcy of 2012. But that time is... not yet.

http://www.fool.com/investing/general/2012/06/06/how-to-profit-from-the-great-greek-bankruptcy-of-.aspx?source=ihpdspmra0000002&lidx=3

National Bank of Greece (NYSE: NBG  )

 Coca-Cola Hellenic Bottling (NYSE: CCH  ) 

 DryShips(Nasdaq: DRYS  )

 Diana Shipping (NYSE: DSX  )

Excel Maritime (NYSE: EXM  ) .

Stocks Near 52-Week Lows Worth Buying

Just as we examine companies each week that may be rising past their fair value, we can also find companies potentially trading at bargain prices. While many investors would rather have nothing to do with companies tipping the scales at 52-week lows, I think it makes a lot of sense to determine whether the market has overreacted to the downside, just as we often do when the market reacts to the upside.

Here's a look at a fallen angel trading near the 52-week lows that could be worth buying.

It's all about being greedy when others are fearful. 

Coca-Cola Hellenic (NYSE: CCH  ) , the second-largest bottling company in the world and the exclusive bottler of Coca-Cola (NYSE: KO  ) products in the region, exclusivelydistributes sparkling beverages, juices, and energy drinks in 28 countries. Because of weakness in the region and heavy investments into the company over the coming years, results haven't been fantastic, as is evidenced by the 2% drop in unit volume and its cash outflow of 32 million euros in the latest quarter.

However, investors need to keep in mind that barriers to entry remain extremely high in bottling. The Coca-Cola brand name when combined with Coke's marketing budget give Coca-Cola Hellenic incredibly strong pricing power. It's also worth noting that energy drinks and Coke Zero products showed strong year-on-year growth. At less than 10 times forward earnings, Coca-Cola Hellenic has a good mix of value and a strong brand name at its current price.

• Add Coca-Cola Hellenic to My Watchlist.
• Add Keynote Systems to My Watchlist.
• Add HudBay Minerals to My Watchlist.

http://www.fool.com/investing/general/2012/05/29/3-stocks-near-52-week-lows-worth-buying.aspx?source=itxsitmot0000001&lidx=6 

Did Buffett indeed make a mistake by not selling Coke?

Lessons from Buffett’s Decision not to Sell Coke: “I talked when I should have walked”
Written by Greg Speicher on August 2, 2010

In his 2004 letter to the shareholders of Berkshire Hathaway, Warren Buffett admitted that he made a mistake by not selling certain stocks that were “priced ahead of themselves.” The episode contains some powerful lesson that we can use to improve our investment results. 

Let’s look at how the businesses of our “Big Four” – American Express, Coca-Cola, Gillette and Wells Fargo – have fared since we bought into these companies. As the table shows, we invested $3.83 billion in the four, by way of multiple transactions between May 1988 and October 2003. On a composite basis, our dollar-weighted purchase date is July 1992. By yearend 2004, therefore, we had held these “business interests,” on a weighted basis, about 12½ years.
 
In 2004, Berkshire’s share of the group’s earnings amounted to $1.2 billion. These earnings might legitimately be considered “normal.” True, they were swelled because Gillette and Wells Fargo omitted option costs in their presentation of earnings; but on the other hand they were reduced because Coke had a non-recurring write-off.
 
Our share of the earnings of these four companies has grown almost every year, and now amounts to about 31.3% of our cost. Their cash distributions to us have also grown consistently, totaling $434 million in 2004, or about 11.3% of cost. All in all, the Big Four have delivered us a satisfactory, though far from spectacular, business result.
 
That’s true as well of our experience in the market with the group. Since our original purchases, valuation gains have somewhat exceeded earnings growth because price/earnings ratios have increased. On a year-to-year basis, however, the business and market performances have often diverged, sometimes to an extraordinary degree. During The Great Bubble, market-value gains far outstripped the performance of the businesses. In the aftermath of the Bubble, the reverse was true.
 
Clearly, Berkshire’s results would have been far better if I had caught this swing of the pendulum. That may seem easy to do when one looks through an always-clean, rear-view mirror. Unfortunately, however, it’s the windshield through which investors must peer, and that glass is invariably fogged. Our huge positions add to the difficulty of our nimbly dancing in and out of holdings as valuations swing.
 
Nevertheless, I can properly be criticized for merely clucking about nose-bleed valuations during the Bubble rather than acting on my views. Though I said at the time that certain of the stocks we held were priced ahead of themselves, I underestimated just how severe the overvaluation was. I talked when I should have walked.
 
As the following charts show, of the big four, Coke and Procter & Gamble reached the most extreme levels of over-valuation. According to Value Line, Coke sold at an average P/E ratio of 47.5 during 1999, its peak being considerably higher.  Procter & Gamble sold at an average P/E of 30.8 during 1999.

(all graphs show quarterly prices and P/E ranges from 1/1/1996 to 7/30/2010)

American Express

Coca-Cola

Procter & Gamble

Wells Fargo

(click images to enlarge)

 
What lessons can be learned from this?
 
If you’ve read my investing blueprint you know that I am a strong proponent of patient business-like investing for the long-term. This is a proven way to create wealth. However, at a sufficiently high price, all assets – no matter what their level of quality – should be sold.
 
What is sufficiently high? When the price clearly exceeds all reasonable estimates of the Net Present Value of the business’s earnings after taking taxes into consideration. 

What can make this difficult is that the intrinsic value – the net present value of all future cash flows – of a truly great business may be strikingly high in relation to its current earnings. Consider that a 50-year bond with economics similar to those of Coke (ROE of 30% and a payout ratio of 66.67%) would have a net present value of 46x earnings, assuming a discount rate of 8%. (Here’s the data.)
https://spreadsheets.google.com/pub?key=0AqDABX1wIfxZdHJzb0tlZHh5Y1gwNUI3WXc0M0lLRXc&hl=en&output=html 
 
However, unlike a bond where the coupon is set and contractually obligated, a holder of equity has no future guarantee other than his judgment about the competitive advantages of the business.  At the peak of the bubble, Coke’s price appeared to more than fully reflect the next 50 years of earnings and then some.
 
Plus, the proceeds of the sale could have been redeployed in cheaper assets, thereby raising the intrinsic value of Berkshire Hathaway. The challenge is that, unless you have a specific immediate purchase in mind, you never know how long you will need to wait to re-invest the funds of a sale.
 
If you buy or hold an overvalued security it will materially impact your future performance. Many stocks purchased during the Internet Bubble have shown a large increase in earnings with no progress in the price of the stock.
 
Consider an example. In 1999, Microsoft earned $.70 a share, sold for an average P/E of 49.8 and traded between $34 and $60 per share. Ten years later during 2009, it earned $1.62 per share, more than doubling its earnings, but sold for an average P/E of 13.4 and traded no higher than 31.5. Lesson: don’t overpay – it’s costly!
 
Confirmation Bias
 
Beware of confirmation bias, which Wikipedia defines as, “a tendency for people to favor information that confirms their preconceptions or hypotheses whether or not it is true.” Buffett was long on record as saying that his favorite holding period was forever, going so far in his 1990 shareholder letter as to call Capital Cities/ABC, Coca-Cola, GEICO, and Washington Post his “permanent four”. The risk with confirmation bias is that you are liable to act irrationally even at the expense of your own interests.
 
How Much Cash Will You Get Back?
 
If you are a businesslike investor, you should actually expect that a business in which you invest will deliver more cash than you put in. This is how Buffett operates as is evident from the comments about how much of his cost for purchasing shares in the “Big Four” he had already received. This is a lesson in how to think in a businesslike fashion about investing.
 
“The glass is invariably fogged”
 
Investing – whether deciding on a new purchase or whether to hold an existing investment – is always a business of judgment fraught with many uncertainties: “the glass is invariably fogged.” Accept this and get on with it by putting a premium on hard work, exceptional research, and following a rational investing process with great discipline.
 
What are your thoughts? Did Buffett indeed make a mistake by not selling Coke?

Read below or add a comment...

1. M. Ofenheim

   August 3, 2010 at 4:19 pm

   I don’t believe he did make a mistake by selling Coke. I one thing I learned reading and listening to Buffett is that all currencies are a race to the bottom. A dollar will simply buy less in 20 years than it does today.

   I doubt Coke will outperform the S&P during the next 5-10 years, however a business like Coke is one of the few franchises in the world that possesses true pricing power. Coke will sell just as many cans, bottles and syrup, if not more and at a higher price due to natural inflation. As result the value of the business reflected in the total market cap should be preserved.

   Of course we need to add the following caveats:
   1. Is there Competant management?
   2. Are they enhancing the existing brands?
   3. Are they adding brands either thru internal development or fair valued purchases of outside businesses (i.e. Vitamin Water)?
   4. Are they increasing shareholder value (share buybacks, increasing dividends)?

   Reply
2. Drew Kennedy

   August 4, 2010 at 10:57 am

   Consider capital gains taxes before selling.

   Imagine you bought a company for $500, thinking its fair value is $1000. If the company is currently trading at $1500, you would say it is overvalued and might consider selling. If you sold, and the capital gains tax rate was 30%, then you would owe $450 in taxes and have $1050 after tax.

   By selling you gain the ability to invest the cash elsewhere. But if the business you are selling is Coca-Cola, Gillette, or American Express, it will be hard if not impossible to find a better business. Even if you know of similarly great businesses, there is no guarantee that they will be cheap.

   On the other hand, by selling you lose out on any dividends, and real business growth. You will also be losing purchasing power due to inflation (should you hold cash). Finally there is no guarantee the price will fall sufficiently to make the business a bargain once again.

   If the business is terribly overpriced, your taxes will be low, and you have better companies at cheaper prices to invest in, then the decision is that much easier.

   Reply
3. Drew Kennedy

   August 6, 2010 at 10:49 am

   My math was wrong.

   The tax of $450 was based on 1500-(1500*.30). I incorrectly included the total sales price and didn’t take into account the purchase cost.

   Reply

http://gregspeicher.com/?p=841

The Approach Warren Buffett uses in deciding whether or not to invest in a company

BRINGING IT ALL TOGETHER

The remarks of Warren Buffet and analysis by Buffett authors suggest that, at the very least, Warren Buffett looks at the following aspects of a corporation and its operations. They can be put in the form of questions that any sensible investor should ask before considering a stock investment.

BASIC QUESTIONS TO ASK

1. Does the company sell brand name products that are likely to endure?
2. Is the business of the company easily understood?
3. Does the company invest in and operate businesses within its area of expertise?
4. Does the company have the ability to maintain or increase profitability by raising prices?
5. Is the company, looking at both long-term debt, and the current position, conservatively financed?
6. Does the company show consistently high returns on equity and capital?
7. Have the earnings per share and sales per share of the company shown consistent growth above market averages over a period of at least five years?
8. Hs the company been buying back its shares, and if so, has it bought them responsibly?
9. Has management wisely used retained earnings to increase the rate of return to shareholders?
10. Is the company likely to require large capital sums to ensure continuing profitability?

See case studies.

This would only be the first stage of the process. The next, and most important question, is determining the price that an investor such as Warren Buffet would pay for the stock, allowing for the margin of safety.

CASE STUDIES

These examples will take you through the method of company analysis advanced on this website, which we believe to be similar to the approach Warren Buffett uses in deciding whether or not to invest in a company.

COCA COLA - CASE STUDY

In answering the question for ourselves whether Coca Cola is a company worth consideration as an investment, at the right price, we have used summary and other figures available from Value Line.

QUESTION 1: DOES THE COMPANY SELL BRAND NAME PRODUCTS THAT ARE LIKELY TO ENDURE?

The answer to this seems quite simple. The major product of the company has been around for many years, is sold worldwide and is considered the best-known brand name in the world. More importantly, its customers would not do without it, and have demonstrated a loyalty that makes it unlikely it would change to other products. It also has other well-known brands on its books – Sprite, Fanta, Evian, Minute Maid, PowerAde.

2. IS THE BUSINESS OF THE COMPANY EASILY UNDERSTOOD?

We think so. Its core operation is the production and distribution, both for itself and under franchise, of non-alcoholic beverages and associated products.

3. DOES THE COMPANY INVEST IN AND OPERATE BUSINESSES WITHIN ITS AREA OF EXPERTISE?

We would think so. Consideration of the Value Line information suggests that the company restricts itself to its core operations. We do not see it dabbling in areas outside its expertise.

4. DOES THE COMPANY HAVE THE ABILITY TO MAINTAIN OR INCREASE PROFITABILITY BY RAISING PRICES?

The real question here is whether, if Coke were to lift its prices by a margin that would allow it to keep pace with inflation, sales would suffer. This is unlikely.

5. IS THE COMPANY, LOOKING AT BOTH LONG-TERM DEBT, AND THE CURRENT POSITION, CONSERVATIVELY FINANCED?

a) Long term debt to profitability

The long-term debt of this company in 2002 was 2700 million dollars. The profit for that year was 4134 million dollars. At this rate, Coke could wipe out its long-term debt in .65 of a year, just over six months.

b) Current ratio

In 2002, Coke had current assets of 7352 million dollars and current liabilities of 7341 million dollars, a ratio of debt to assets of .99. This is lower than would be the desired ratio for industrial companies, but having regard to the nature of the business, and the ready cash flow, is acceptable.

c) Long term debt to equity

In 2002 the long-term debt was 2700 million dollars and shareholders equity was 11800 million dollars a comfortable ratio of .22.

6. DOES THE COMPANY SHOW CONSISTENTLY HIGH RETURNS ON EQUITY AND CAPITAL?

The company has shown an average rate of return on equity over the past five years of 37.08%. In the same period, it showed an average return on capital of 33.6% .The figures are consistent.

Year	ROE	ROC
1998	42.0	39.1
1999	34.0	31.5
2000	39.4	36.4
2001	35.0	31.9
2002	35.0	29.1
Average	37.08	33.6

7. HAVE THE EARNINGS PER SHARE AND SALES PER SHARE OF THE COMPANY SHOWN CONSISTENT GROWTH ABOVE MARKET AVERAGES OVER A PERIOD OF AT LEAST FIVE YEARS?

The figures for this period are as follows.

Year	EPS	+ or - %	SPS	+ or - %
1997	1.64		7.64
1998	1.42	-13.4	7.63	-.13
1999	1.30	-8.45	8.01	+4.98
2000	1.48	+13.85	8.23	+2.74
2001	1.60	+8.11	7.06	-14.2
2002	1.66	+3.75	7.92	+12.18

Looking at a five-year rolling period, we can calculate, using a hand-held Texas Instruments BA-35 Solar Calculator, the increase in earnings and sales over the rolling five-year period 1998-2002. For earnings, this is 16.9 %, for sales only 3.8%. The compound rate of return for earnings is 3.185, for sales, .75%.

This is not a strong rise in earnings or sales, and the question would be whether this is as a result of a slow-down in the US and world economies over this period or whether there is some more structural reason.

8. HS THE COMPANY BEEN BUYING BACK ITS SHARES, AND IF SO, HAS IT BOUGHT THEM RESPONSIBLY?

In 1998, the company had common shares outstanding of 2465.5 million. In 2002, the figure was 2471 million. The shares on issue are basically unchanged.

9. HAS MANAGEMENT WISELY USED RETAINED EARNINGS TO INCREASE THE RATE OF RETURN TO SHAREHOLDERS?

The company has the following earnings per share and dividend per share record over a five-year period.

Year	EPS	DPS
1998	1.42	.60
1999	1.30	.64
2000	1.48	.68
2001	1.60	.72
2002	1.66	.80
Total	7.46	3.44

The company has therefore retained earnings totalling $4.02. In 1998, the shares reached a low of $53.6. In 2002, the shares reached a high of $57.9. An investor who bought at the lowest price in 1998 and still had them at the highest price in 2002 would have been showing a profit of $4.30. Thus the shares would have just slotted into Warren Buffett’s requirement for showing an increase in market value of a dollar for every dollar retained.

Using the approach of Mary Buffett and David Clark, we could calculate the percentage increase in earnings per share resulting from the retained profits. EPS in 1998 were 1.42, and in 2002 were 1.66, an increase of .24. Thus, from the total earnings retained of $4.02, earnings have increased by a total of .22, a percentage increase of 5.97%: not high.

10. IS THE COMPANY LIKELY TO REQUIRE LARGE CAPITAL SUMS TO ENSURE CONTINUING PROFITABILITY?

Value Line suggests that in the two years following 2002, the company would be spending about .40 a share on capital items. The long-term average is .31, unadjusted for inflation. These figures seem to be in line with historical expenditures.

This case study is a demonstration only and is not intended to influence or persuade visitors to this site to make any investment decisions; they should make their own decisions, based on their own research, personal and financial circumstances, and after consultation with their own financial or investment advisers.

BOEING (BA) - CASE STUDY

In answering the question for ourselves whether Boeing is a company worth consideration as an investment, at the right price, we have used summary and other figures available from Value Line.

QUESTION 1: DOES THE COMPANY SELL BRAND NAME PRODUCTS THAT ARE LIKELY TO ENDURE?

The answer to this seems quite simple. The major product of the company has been around for many years, is sold worldwide, and is recognised as a brand name by airlines and air passengers. In recent years, other passenger brand names such as Airbus have added competition. The choice of which airplane an airline buys is a matter of preference, rather than compulsion, and will depend upon factors such as price, safety, back up and design.

The brand name is good, but so is the competition.

2. IS THE BUSINESS OF THE COMPANY EASILY UNDERSTOOD?

We think so. Its core operation is the design and manufacture of airplanes.

3. DOES THE COMPANY INVEST IN AND OPERATE BUSINESSES WITHIN ITS AREA OF EXPERTISE?

We would think so. Consideration of the Value Line information suggests that the company restricts itself to its core operations. We do not see it dabbling in areas outside its expertise.

4. DOES THE COMPANY HAVE THE ABILITY TO MAINTAIN OR INCREASE PROFITABILITY BY RAISING PRICES?

This will totally depend upon the condition of the airline industry and the extent of the competition at any given time. The near certainty that people will continue to fly in ever-increasing numbers is dampened by the possibility of any one of a number of things that could reduce passenger flights – terrorism, crashes, other and more serious SARS type disease outbreaks.

5. IS THE COMPANY, LOOKING AT BOTH LONG-TERM DEBT, AND THE CURRENT POSITION, CONSERVATIVELY FINANCED?

a) Long term debt to profitability

The long-term debt of this company in 2002 was 12589 million dollars. The profit for that year was 2275 million dollars. At this rate, Boeing could wipe out its long-term debt in 5.53 years. This is a long period.

b) Current ratio

In 2002, Boeing had current assets of 16855 million dollars and current liabilities of 19810 million dollars, a ratio of debt to assets of .85. This is lower than would be the desired ratio for industrial companies.

c) Long term debt to equity

In 2002 the long-term debt was 12589 million dollars and shareholders equity was 7696 million dollars a very high ratio of debt to equity of 1.64. Benjamin Graham thought that an industrial company should not have a ratio in excess of 1.

6. DOES THE COMPANY SHOW CONSISTENTLY HIGH RETURNS ON EQUITY AND CAPITAL?

The company has shown an average rate of return on equity over the past five years of 20.12%. In the same period, it showed an average return on capital of 12.02% .The figures indicate that use of debt financing has helped to increase the company returns on equity.

Year	ROE	ROC
1998	9.1	7.4
1999	17.7	12.9
2000	22.8	14.7
2001	21.4	12.2
2002	29.6	12.9
Average	20.12	12.02

7. HAVE THE EARNINGS PER SHARE AND SALES PER SHARE OF THE COMPANY SHOWN CONSISTENT GROWTH ABOVE MARKET AVERAGES OVER A PERIOD OF AT LEAST FIVE YEARS?

The figures for this period are as follows.

Year	EPS	+ or - %	SPS	+ or - %
1997	.63		47.05
1998	1.15	82.54	59.87	27.25
1999	2.19	90.43	66.60	11.24
2000	2.84	29.6	61.36	-7.87
2001	2.79	-1.76	72.94	18.87
2002	2.82	1.07	67.61	-7.30

Looking at a five-year rolling period, we can calculate, using a hand-held Texas Instruments BA-35 Solar Calculator, the increase in earnings and sales over the rolling five-year period 1998-2002. For earnings, this is very high; EPS has risen from $1.15 to $2.82, a total percentage rise of 145.21 %. Sales have risen per share from $59.87 to $67.61, a total rise of only 12.92%. The compound rate of return for earnings is 19.65%, for sales, 2.46%.

The disparity between earnings growth and sales growth suggests that the company has, for whatever reasons, managed to increase profitability well in excess of the rise in sales. Any person considering investment in this company would try and find out why.

8. HS THE COMPANY BEEN BUYING BACK ITS SHARES, AND IF SO, HAS IT BOUGHT THEM RESPONSIBLY?

In 1998, the company had common shares outstanding of 937.6 million. In 2002, the figure was 799.6 million. The number of shares on issue has been substantially reduced, suggesting a share buy back that may be one reason for increased earnings per share ratios.

9. HAS MANAGEMENT WISELY USED RETAINED EARNINGS TO INCREASE THE RATE OF RETURN TO SHAREHOLDERS?

The company has the following earnings per share and dividend per share record over a five-year period.

Year	EPS	DPS
1998	1.15	.56
1999	2.19	.56
2000	2.84	.59
2001	2.79	.68
2002	2.82	.68
Total	11.79	3.07

The company has therefore retained earnings totalling $8.72. In 1998, the shares reached a low of $29. In 2002, the shares reached a high of $51.10. An investor who bought at the lowest price in 1998 and still had them at the highest price in 2002 would have been showing a profit of $22.10. Thus the shares would have easily slotted into Warren Buffett’s requirement for showing an increase in market value of a dollar for every dollar retained.

Of course, and this shows Mr Market as a real factor, an investor who bought at the 1998 high price of $56.30, and sold at the 2002 low price of $28.50 would be showing a substantial loss on the investment.

Using the approach of Mary Buffett and David Clark,in The New Buffettology,  we could calculate the percentage increase in earnings per share resulting from the retained profits. EPS in 1998 were 1.15, and in 2002 were 2.82, an increase of 1.67. Thus, from the total earnings retained of $8.72, earnings have increased by a total of $1.67, a percentage increase of 19.15%: above market rates of return.

10. IS THE COMPANY LIKELY TO REQUIRE LARGE CAPITAL SUMS TO ENSURE CONTINUING PROFITABILITY?

Value Line suggests that in the two years following 2002, the company would be spending about $1.00 a share on capital items. The long-term average is $1.33, unadjusted for inflation. These figures seem to be a little less than historical expenditures.

This case study is a demonstration only and is not intended to influence or persuade visitors to this site to make any investment decisions; they should make their own decisions, based on their own research, personal and financial circumstances, and after consultation with their own financial or investment advisers.

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