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The Coca-Cola Company Message Board

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  • Novalis_97 Novalis_97 Aug 16, 1998 10:09 PM Flag

    KO's price about where it should be

    Nothing, not even bacteria, can grow at 15% a
    year forever. We live in a finite world with limited
    substrate and positive-NPV projects, and all companies
    (even today's fastest growing ones) will eventually
    reach their growth limits.

    Every company goes
    through a life cycle. In the beginning, they grow slowly,
    if at all, as they just get off the ground. Then,
    they enter an "exponential" phase during which they
    experience their greatest growth. Then, they hit their
    "maturity" phase, where they bob-around at the same level or
    afterwards decline.

    In the distant future, when
    every man, woman, and child on Earth drinks 3650 Cokes
    a year (10 a day like me), Coke will hit its
    maturity phase. But we want to come up with a growth rate
    that will summarize Coke's various growth rates
    throughout its entire life.

    Given Buffett puts the
    Washington Post's growth rate at 6%, it's reasonable to
    assume Coke's is higher, say 8%. Yes, it could be a
    little higher or a little lower, but that is the hard
    part -- estimating the "coupons" you should plug into
    the perpetuity formula. Buffett wrote,

    "In The
    Theory of Investment Value, written over 50 years ago,
    John Burr Williams set forth the equation for value,
    which we condense here: The value of any stock, bond or
    business today is determined by the cash inflows and
    outflows - discounted at an appropriate interest rate -
    that can be expected to occur during the remaining
    life of the asset. Note that the formula is the same
    for stocks as for bonds (meaning perpetuities). Even
    so, there is an important, and difficult to deal
    with, difference between the two: A bond has a coupon
    and maturity date that define future cash flows; but
    in the case of equities, the investment analyst must
    HIMSELF estimate the future 'coupons.'"

    Should
    you plug in 0, 1, 2, 3, 4, 5, 6, 7, or 8% as the
    owner earnings' growth rate, g, in the perpetuity
    formula? No kidding it changes your intrinsic value
    estimate dramatically if you change your growth
    assumption. That was the whole point of the "Some Valuation
    Math" section in Buffett's 1991 Letter. But that is
    exactly what the investor has to do or else they have no
    idea of intrinsic value and are consequently investing
    "blind." I use the Washington Post's 6% as a proxy for
    Coke (i.e., the growth rate of Coke, the best company
    in the world, should be higher than 6%, say
    8%).

    You will not be confused if you distinguish in your
    mind short-term growth rates from long-term growth
    rates. It is the long-term growth rate you plug into the
    perpetuity formula, not the short-term one, which is only
    transitory. As I told you before, if you expect Coke's owner
    earnings to remain 20% a year forever, then by all means
    you can conclude that Coke's intrinsic value is
    infinite. Or if you take 20% to be a short-term growth
    rate, you can do a two-stage DDM followed by a
    one-stage. But the perpetuity formula is sound (for
    long-term growth rates), and ultimately I trust Buffett
    more than you.

 
KO
44.12+0.16(+0.36%)Nov 25 4:01 PMEST

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