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# The Coca-Cola Company Message Board

• Novalis_97 Novalis_97 Apr 2, 1998 8:01 PM Flag

## Value = present value of cash flows, not

I am tired of people citing Coke's P/E ratio as proof that Coke is "overvalued." The only way to determine a company's true value is to compute the present value of its future cash flows. Using Coke's 1997 numbers, Coke's intrinsic value is as follows:

Cash flow = net income + noncash charges (depreciation and amortization) - capital expenditures (purchases of property, plant, and equipment).

So Coke's 1997 cash flow = \$4,129 mil. + \$626 mil. - \$1,093 mil. = \$3,662 mil. Being very conservative, assume Coke can grow this figure 5% a year forever. (The average since 1990 has been around 19%, so 5% is safe.)

Then, to compute the intrinsic value, use the 30-year bond rate as the discount rate in the formula for a growing perpetuity. As Buffet does, add a correction factor to the 30-year bond rate if it is cyclically, as it now is. I'll add 1% as a correction factor. Today's closing bond yield was 5.843%, so I'll use 6.843% as the discount rate.

Growing perpetuity formula: Present value of growing perpetuity = Cash flow / (discount rate - cash flow's growth rate)

= \$3,662 mil. / (0.06843 - 0.05) = \$190.7292 bil.

NOTE: \$190.7292 bil. is the intrinsic value of Coke for 1996, not 1997, since the growing perpetuity formula calculates the intrinsic value for the year PRIOR TO the beginning of the cash flows. To find the 1997 intrinsic value figure, just use the future value formula with a discount rate of 5% to move the value ahead one year in time:

Value in 1997 = Value in 1996 * (1.05) = \$190.7292 bil. * 1.05 = \$200.2656 billion. This was the intrinsic value of Coke at
the end of 1997. At that time, Coke had 2,470.718 bil. shares outstanding. So the Intrinsic (or true) price per share of Coke at
that time was \$200.2656 bil. / 2,470.718 bil. shares = \$81.05564. On Dec. 31, 1997, Coke's closing price was \$66.6875. So Coke
was selling at a 17.7% margin of safety or discount to the intrinsic value: (\$81.005564 - \$66.6875) / \$81.005564 = 17.7%.

But actually the margin of safety is actually greater, since we used a conservative 5% as the cash flows' growth rate. In actuality, Coke's cash flow growth rate has averaged 19% since 1990. So \$81 is on the low side of Coke's possible RANGE of intrinsic values.

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• Thank you! I check out the Motley fool on a regular basis.

• Norvalis is a guy who has posted some ideas on stock valuation on this board. I pointed out that one of the formulas he used in valuing KO stock was misapplied. This is summarized in a couple of my earlier posts.

As I noted earlier, while it is valuable to understand valuation methodology (i.e. formulas), it is even more important to evaluate the competitive position and strategy of any business you are considering investing in.

The best web site I've seen on investing is the Motley Fool site, whether you are a novice or experienced investor. Good luck.

• This BB (KO) is one of the more interesting BBs of the 60 or so I scan. Minimal emotional slander and more effort at two way discussions of stock value.

• ...and correct the error in your valuation methodology before you continue giving other people advice on how to value securities.

If after reading that post, you don't think you are in error, please answer this question. What is the implied value of KO if you use a 7% growth rate assumption for the perpetuity instead of a 5% rate?

Also, with regard to adding back capital expenditures, that is hardly a revolutionary concept invented by Buffett. The term is "free cash flow"; any experienced investor adds back capital expenditures because they are not cash flows available to investors; they are required to sustain the company's growth rate.

• Cash flow is the amount of actual cash that flows or makes it way through a firm throughout its fiscal year. It accounts for all of a firm's sales and expenses in the form of "net income" and accounts for non-cash items as well, like depreciation and amortization. Warren Buffett has gone one step further by subtracting capital expenditures from the traditional definition of cash flow (net income plus depreciation&amortization).

• There you will find Warren Buffett's formula and how it is used.

• Does anyone follow BB:CCLAY (Coca Cola Amatil)? I haven't seen a quote posted for it on Yahoo since COB March 31st.

• jflyboy

Coke has split twice in the 90's (5/96 and 5/92) both at a valuation around 80/share. There is at present lots of institutional buying of Coke shares. Total purchased over the last three months total 43 million plus shares. Annual meeting is Wednesday after next. My guess is they announce at the meeting or just before or after. May 80 options are not too badly priced at around 3 x 3 1/4 or so. If capital is tight you could still take advantage of a split run up on coke with the options.

• I believe that KO split when it hit about \$82 per share. Does anyone
have or know if there is talk of a split at this time.

• I'm not overly concerned about when we'll split. I'm primarily a value investor, and splits have little impact on a company's value. They usually have a short-term impact on the price of a company's stock, but value and price are two very different concepts. Over the long haul, price will generally follow value, but in the short run, the two can diverge significantly.

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