TIP724: Key Insights From Coca-Cola's Golden Era
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You're listening to TIP. Coca-Cola might just be the most iconic business in history. Not only is Coke one of the most recognized brands in the world, but it's also one of the most consumed brands worldwide.

Its products were drunk over 2.2 billion times yesterday. And that's not hyperbole. It just speaks volumes to the reach and staying power Coke has built over decades. When I started digging into Coke's rich history, strategy, and leadership, I began to understand why it's created so much value for shareholders, and how it's managed to embed itself into everyday life in nearly every corner of the globe. In this episode, I'll examine Coca-Cola through a few key lenses.

We'll explore the remarkable leadership of Roberto Goizueta, the chemical engineer turned CEO who helped right the ship when the business had lost its way. Under his tutelage, Koch became a more focused business. It scaled intelligently and embraced capital allocation to its fullest extent. His use of economic value added to just guide decision-making is an absolute masterclass in financial discipline from which I think any investor or business owner can draw insights.

Next, we'll examine Coca-Cola's enduring competitive advantages, from its untouchable brand and secret recipe, to its economies of scale, and its network effects that rival those of some of the world's biggest tech companies. We'll also examine why it's nearly impossible to replicate Coke's unique taste, distribution, or mental real estate inside customers' minds. Coke is the gold standard when discussing moats, and I'd like to help explore exactly why that is.

And last but not least, we'll revisit Berkshire Hathaway's investment in Coke to better understand Warren Buffett and Charlie Munger's obsession with it in the 1980s. We'll walk through Buffett's 12 tenets which he used to analyze the Coca-Cola business and investment opportunity. Plus, we'll closely examine how Munger used a series of just brilliant metal models to imagine Coke as a $2 trillion business. The thought process Munger used here is a masterclass in multidisciplinary thinking. I know fans of metal models will thoroughly enjoy it.

This episode is really for investors who want to sharpen their understanding of durable, competitive advantages. So, if you're a curious stock investor researching legendary capital allocators, or just a business owner looking for an edge, this one's for you. Now, let's get right into this week's episode about Coca-Cola.

Since 2014 and through more than 180 million downloads, we've studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now for your host, Kyle Grieve.

Welcome to the Investors Podcast. I'm your host, Kyle Grieve, and today we'll be discussing one of the best known brands the world has ever known, Coca-Cola. I'll be focused on looking at Coca-Cola through a few primary lenses, which are the Roberto Goizueta years, the Berkshire Hathaway connection, and its competitive advantages that have been built out that still exist today. Now, I've spent considerable time reading about Coca-Cola over the years. While I admit it's a well-entrenched strongmo business,

The potential returns just have never felt attractive enough for me to warrant an investment. And for that reason, my knowledge of Coke has always been focused on its competitive advantages more so than the unit economics. The competitive advantages of Coke are pretty simple. The first one is the brand. Every person listening to this podcast has heard of Coke. Very few businesses can make this claim, but Coke is one of the most recognized brands in the entire world.

The second is intellectual property. While Coke has a mountain of imitators and competitors, nothing out there just tastes like Coca-Cola. The taste is very distinct.

And I've yet to find an off-brand Coke that tastes nearly as good as the Coca-Cola brand. The third one is economies of scale. Coca-Cola has unique scale advantages that just really aren't inimitable. Their distribution system is nearly impossible to penetrate, and they have set up the business to have tentacles in nearly every area of earth. This share of people's mouths, as Goizueta put it, is sky high, and few companies have the capabilities that Coke has.

And the last one here is network effects. Most people associate network effects with tech companies, and it's easy to see why. Several of the best companies on earth have this competitive advantage. Businesses like Meta, Amazon, and Google have some of the strongest network effects in existence. But ask yourself, when was the last time that you walked into a grocery store, convenience store, or gas station and didn't see a Coca-Cola product that was prominently displayed? The reason is that as more people want Coca-Cola products, it forces retailers to carry their products.

Throughout this episode, I'll go a lot more in depth into all four of these competitive advantages. Now, like all businesses, Coca-Cola has grown into the behemoth that it is today. Throughout its history, it's had periods of great growth. And that is the period that I kind of want to focus on most today.

And it just so happens that this period in which Coca-Cola delivered outsized returns to its shareholders coincided with a few keys. The most important one being Roberto Goizueta's leadership. We'll be covering many of his leadership skills and how he helped provide so much value to shareholders while he was the leader of the company. Business success can also be a function of being at the right time and place. And I think Goizueta took over when Coca-Cola was just ripe for scaling. We'll go over some of the unique setups that Coca-Cola had working for them as a tailwind

that are now near fully penetrated. And then finally, it's no coincidence that Warren Buffett invested in Coca-Cola right as they were beginning their rapid growth trajectory. Warren and Charlie understood and might still understand Coke better than nearly anybody. So I would be amiss not to mention some of their great commentary on the business.

While their ownership of Coca-Cola was excellent for the first 10 years, the returns faded, but they have been beating the index since a massive peak in 1998. We'll review why Buffett has held Coca-Cola for as long as he had.

But let's start this episode by briefly discussing Coke's origin story and their business model. So I'm not going to get too much in depth here on Coke's origin story, as there are just full documentaries out there on YouTube that you can watch for free that does it at a very high level. But I do want to discuss a few things that I think are important. The first one is that Coca-Cola has been around for a really long time. So it was initially formulated in 1886 by a doctor named John Pemberton.

Funny enough, it was originally an alcoholic beverage and was considered a "Coca Wine" alternative. It was reformulated to avoid prohibition laws, and the alcohol was removed from the recipe. At that time, it was just selling in an Atlanta pharmacy as a fountain drink in those early days. Pemberton eventually sold the business, which was renamed Coca-Cola, to a gentleman named Asa Candler. Asa Candler incorporated Coca-Cola in 1892. And from then on, the company just grew like wildfire.

Once Candler took over, he began expanding its distribution and marketing nationwide. By 1899, the first bottling agreement was signed, which was a major turning point for soda producers. Up until this point, all soda was offered as a fountain drink. Moving forward, bottlers would be taking care of a lot of the distribution, which would obviously allow for a mass distribution. In 1919, Coca-Cola was sold to Ernest Woodruff for about $25 million.

Now, that's important because Ernest's son, Robert Woodruff, later became the president of Coca-Cola and continued with the leadership role as part of the business for nearly 60 years. Robert Woodruff was also integral into the hiring of Roberto Goizueta. Over the next few decades, the business expanded its products and offerings to things like Fanta, Sprite, and Minute Maid. International expansion was working, and therefore, their global marketing force was beginning to mold into the powerhouse that it became. But you know,

As with all successful businesses, competition begins heating up. And that's exactly what happened in the 1970s. Pepsi had been a big competitor. And during this time period, Coca-Cola actually started losing US market share to Pepsi. Now, I'll end the intro there because the rest of it, I think, is going to take off once I really get into Roberto Goizueta. But before we transition here, I'd like to share Coca-Cola's business model. It might be a little different than you think if you haven't spent much time researching the business. Robert Leonard :

So Coca-Cola has two primary business lines right now, today.

The first is the sale of its concentrates to its bottlers. This line of business is very attractive as it's asset light and high margin. It's pretty simple. They literally just sell the concentrates and the syrup to their bottlers and to their fountain retailers. In the case of a bottler, they do a lot of the work by adding things like water, sweeteners, packaging the product, and handling logistics. The second business line is the finished product operations. This is a lower margin and more capital intensive business.

For this business segment, Coca-Cola handles end-to-end product production. So they're basically doing what their bottlers do on top of offering the syrup and concentrates. So using this model, they make more in total gross revenue per unit, but the margins are a lot lower compared to the concentrates business model. Now, when reading about Coca-Cola, I always wondered, why do they have this other business line when it's an inferior business to the concentrates? But

the reason is basically to solve a problem. And that problem is that Coca-Cola needs to have its bottlers working efficiently and preferably all around the world. And if they aren't, Coca-Cola is going to feel the brunt of it because that means that they can't sell as much syrup and obviously they don't want that. So in order to fix that problem, Coca-Cola has a long history of acquiring some of their bottlers to help assist them, get them back on their feet, fix up the operations, and then either resell them or they just keep them in-house. Robert Leonard

Now let's get back here to Roberto Goizueta. So Roberto Goizueta's foray into working with Coca-Cola was pretty fascinating because he had a pretty comfortable job working for his father, Crispula Goizueta, where he was making pretty good money. But after getting some experience under his father, he knew that he just didn't want to go the route of being the boss's son. So his education as a chemical engineer helped him find many different jobs, but he actually settled on a subsidiary of Coca-Cola that was located in Cuba, and he actually took a 50% pay cut just to take that job.

Now, it's important to remember here that Roberto came from a pretty successful line of entrepreneurs. His grandfather instilled some powerful business principles that Roberto brought with him throughout his entire career. These were to be hardworking, to be thrifty, understand the importance of cash, and abhor debt. Robert Leonard :

And from his father, he really learned a lot about alignment. So his father actually suggested that he buy 100 shares of Coca-Cola when he got the job with them. He told Roberto, "You shouldn't work for someone else. You should work for yourself." So his father suggested he buy the shares, which his father then lent him money for. And those shares were reportedly never sold until Roberto's unfortunate passing. Now, Goizueta was forced to leave Cuba during Castro's uprising, but luckily he had this job with Coke waiting for him once he landed in the US.

Goizueta settled in Miami and was well known in the Cuban community there. He was even offered a job that would double his salary outside of Coke, of course, and his wife wanted him to pursue it, but he replied, "I love working at Coca-Cola so much that I'd do it for free if I could." This tends to be a great attitude to have in a leader, and while Goizueta wasn't an executive at the time, you can tell that he clearly loved Coca-Cola very, very much. We now know that Goizueta loved Coca-Cola, but let's review why everyone else, like their customers, also love Coca-Cola.

So Coca-Cola served 2.2 billion servings of its product yesterday. And this is all the brand under its umbrella and not just Coca-Cola itself. But ask yourself why that is. I'm going to take a few stabs at that right now. So in his excellent book, Seven Powers, Hamilton Helmer defines brand as an asset that communicates information and evokes positive emotions in the customer, leading to an increased willingness to pay for the product. He further breaks it down into two parts.

The first part he calls effective valence, which is just a fancy way of saying that strong brands build a good association with its customer. This association is so strong that it's distinct from the objective value of the good, which is why people are more willing to pay up for Coca-Cola than an alternative. And the second is uncertainty reduction. This is less applicable as you usually get certainty in any beverage you buy.

But maybe you've had a bad bottle of Pepsi at some point in your lifetime, which increases your uncertainty of Pepsi. And I've actually had this happen before specifically with Pepsi. In that case, you might prefer the Coca-Cola brand because you've never

a bad experience with the product, which also is true for me. Now, the final relevant part about branding that Helmer mentions is something called hysteresis. So hysteresis means the longer a brand is around, the longer the period of reinforcing actions. This long-term reinforcement causes the brand to become stronger and stronger as it ages. Coke has been around since 1886, which is a huge advantage for the brand. I think Coca-Cola has been very intentional as well about how it's built its brand.

And today it has the money to continue building its customer relationships. So in fiscal 2024, Coca-Cola spent $5 billion on advertising. This figure represents about 11% of the revenue. Spending that much on advertising can be seen as a negative for some companies. The reasoning behind that is that marketing becomes kind of this fixed cost. And if your spending decreases, like let's say you decide to spend less on marketing,

Well, then in that case, sometimes your revenue will decrease and sometimes at an even higher rate of that decrease in advertising spend. But in the case of Coca-Cola, I don't really see it the same way because the brand is just so resilient that would it have decreased growth if it decreased its advertising spend? Probably, but I don't think that it would necessarily lose a lot of its customers, whereas smaller brands in a similar situation that obviously don't have that track record,

probably would get punished for decreasing their advertising. So the point is, is that fixed costs as a percentage of revenue are very valuable to this actual business. And this helps them avoid destroying shareholder value because they have this long, long history, decades long of launching successful advertising campaigns. Now, speaking from personal experience, I like Coca-Cola as a king of colas because I just think it tastes the best out of all of them.

Perhaps subconsciously, with all the advertising that I've been exposed to throughout my whole life, I'm also leaning their way due to the brand's strength. It's pretty hard to say. Now, speaking of taste, this transitions pretty well to discussing Coca-Cola's intellectual property. Since I've already leaned on Hamilton Helmer here, we'll be using the term cornered resources and intellectual property interchangeably. Hamilton defines cornered resources as a preferential access at attractive terms,

to a coveted asset that can independently enhance value. One very valuable part of the corner resource equation is its ability to be transferable.

So if we went through a little thought experiment here using Coca-Cola as an example, we know that the recipe for Coca-Cola is known by a very small group of people. As a side note, there's a myth that only two people know it, but it's a myth. It's not true. But we do know that the group that does know it is very, very small. Now, the important part is that if the Coca-Cola recipe were sold to another business, they can then use it and sell the beverage. If they could sell it as Coca-Cola and not as a different brand, I would guess it would do very, very well.

If the beverage had to be rebranded, it's hard to say if it would do as well because it wouldn't be able to take advantage of all the goodwill and trust that Coca-Cola brand has built with its customers over so many years. But as I mentioned before, I personally like Coca-Cola because of its taste. So if there was another off-brand company that were to get its hands on the recipe, I would have no problem just switching to that brand because I think it's the best tasting cola out there. Whether it says Coca-Cola or not doesn't matter much to me.

From a business sense, if another company were to buy Coca-Cola, the brand and its recipe, I think it would probably do very, very well. There's no reason to believe that this would happen as Coca-Cola has had so much success throughout the years, but let's just pretend it was acquired. You could argue that the acquirer would not manage the business as well as Coca-Cola has over all these years. And I don't have many arguments with that statement either, but maybe it would be the case of if a business like Coca-Cola were acquired,

Perhaps the acquirer would then just allow Coca-Cola to run as kind of an autonomous business unit, which would keep Coca-Cola's strengths intact.

Now Coke has a few other competitive advantages, but we're going to touch on those later on in the episode. For now, I want to get back to visiting Roberto Goizueta's journey as Coke CEO and some of the amazing things that he did for the company. The business required pretty significant adjustments before Roberto Goizueta took over as Coke CEO. In The Buffet Way by Robert Hagstrom, the author mentions domestic and global setbacks that Coca-Cola had to navigate. So there were two primary ones here. The first one was domestic issues.

The company had to deal with legal challenges and reputational damage from some of its disputes that it had with its bottlers. They had allegations of labor mistreatment at its minute-made groves, and they had a backlash from some environmentalists who were criticizing the use of single-use containers. Additionally, the Federal Trade Commission also accused Coca-Cola of violating the Sherman Antitrust Act due to its exclusive franchise system. Let's take a quick break and hear from today's sponsors.

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All right, back to the show. And then there are international setbacks. Coca-Cola's global expansion suffered a pretty significant blow when an Arab boycott was launched after the company granted a franchise in Israel, which basically undid years of investment in that region. In Japan, a key growth market, missteps included exploding 26-ounce take-home bottles and consumers' outrage over artificial coloring in Fanta grape. An attempted reformulation using natural grape skins led

led to fermentation problems resulting in the product being discarded in Tokyo Bay. And Coca-Cola had other problems as well. The CEO, Paul Austin at that time, began diversifying some of the business's revenue streams. Remember that investing back into Coca-Cola was an intelligent move, the direction that Goizueta and Coca-Cola's chairman, Don Keogh, would eventually move towards. So the investments elsewhere were a little bit of a head scratcher.

Under Austin, they invested money into things like wine businesses, water projects, and even shrimp farms. Now, by 1981, Coca-Cola's chairman, Robert Woodruff, who I'd already mentioned, was a legend at Coca-Cola for his lifetime of leadership. He decided that a change was needed. So Hagstrom points out to some pretty significant numbers as to why this decision for change was needed. So between 1974 and 1980, when Austin was CEO, Coca-Cola was the first company to invest in a

Coca-Cola's compounded annual growth rate was about 5.6%, which underperformed the index. And for each dollar that Coca-Cola retained, it only earned about $1.02 in market value, which is very low, as you'll see compared to what Goizueta was able to do under his leadership. Now let's turn to Goizueta. Under Goizueta, Coca-Cola as an investment was a very intelligent one. But how was Goizueta able to do this?

It came down to a few simple concepts that people like Buffett are always on the hunt for. So the first one was just creating shareholder value through intelligent capital allocation. The second one, widening competitive advantages. And the third, focusing specifically on the long term. Goizueta also understood the company's key performance indicators.

He said, solid unit case volume growth is a foundation for generating economic profit, which experience tells us is the key to increasing the value of our share owner's investment. Now, I deeply admire this. As an investor in public companies, I usually have to determine which KPIs are most important to generating shareholder value.

So it's nice to see him point out that this KPI would drive the most value for shareholders. I mentioned earlier that Goizueta did not want to utilize too much debt to run the business. He made some intelligent capital allocation decisions to help avoid becoming over leveraged. For instance, he lowered Coke's dividend payout ratio while raising the dividend to help increase internal investment without having to borrow capital from outsiders. Now let's examine specifically how Goizueta looked at capital allocation.

He had no problem reinvesting in the business, but he wanted the reinvestment to deliver very specific returns. If the returns weren't there, he wasn't okay with investing. In Koch's 1986 shareholder letter, he wrote, "We plan to reinvest a greater portion of our resources in projects and investments that strategically augment and leverage our operations. Investments where the long-term cash returns on invested capital exceed our overall cost of capital." Robert Leonard :

Once again, widening the business's competitive advantage involved a capital allocation decision. Things such as geographic diversification was key to emerging markets where Coca-Cola had a small market share at that time and were trying to widen their moat in those areas. Advertising campaigns also fueled these emerging markets. Now, Goizueta definitely wasn't perfect with his investments, and we'll go over a couple of these later in the episode. But when we look at Goizueta,

And his long-term thinking, I think he had some really, really good commentary on how he observed the investments in Coke. He was also transparent about performance and didn't attempt to hide or obfuscate operating results if they just weren't up to par. For instance, he wrote, in 1993, we generated a total return to share owners of more than 8%, which came on the heels of 1992's total return of nearly 6%.

Those returns fall short of both our track record of the past 12 years and our own long-term expectations. And we remain dissatisfied. And this is exactly how we should be despite some of our significant accomplishments. Another great metric that Goizueta termed, which showcased his capital allocation skills, was economic value added, or EVA.

He came to use EVA because he felt that just too many managers inside of Coca-Cola simply didn't understand the financial impact of the investments that they were making. As a result, he educated them and created EVA to help them guide their decision-making. Here's what David Greising wrote on EVA in his book, I'd Like to Buy the World of Coke. "Performance," he declared, "would be judged on the basis of economic profit, the unit's operating profit after a deduction for the cost of capital."

He had not put a name to it yet, but Goizueta would later refine this notion into a concept that became a trademark of his management approach. Economic value added, he called it. Strategic planning would be taken seriously, Goizueta said, and objectives would be met. Don't even come to us with a project that doesn't yield more money than the cost of the money. So what exactly is EVA? EVA equals net operating profits after tax, no Pat.

minus the product of invested capital and weighted average cost of capital.

So it's pretty simple. If the NOPAT didn't exceed the investment, he just wouldn't greenlight it. I like this because it really shows that Goizueta understood capital allocation and investments. While many executives can increase profits by just spending a ton of money, it doesn't make any sense if the return isn't high enough. Goizueta was steering Coke away from this and wanted to ensure that their investments were high enough to continue creating shareholder value while making Coke a better and better business.

Goizueta was doing such a good job managing and improving Coke that the world's greatest investor, Warren Buffett, took notice. For a period, Coca-Cola was one of Berkshire's most successful investments. From 1988 to 1998, the Coke investment 11x'd, including dividends reinvested. This results in about a 27% annualized return over a decade, which I think any investor wouldn't think twice about piling money into. But let's review why Warren and Charlie spent so much time and effort trying to understand Coke.

That will reveal the keys to what we as value investors can search for in the future to unlock other life-changing opportunities.

Keep in mind when looking at Coke, we'll attempt to look at it from Buffett and Munger's view in the 1980s as a business was a little bit different in terms of the growth stage that it was at then versus what it's at today. Now to do this, we're going to look at some of Buffett's investing tenants that were outlined in the Buffett way. So just to review what these tenants are, they are that the investment should be simple and understandable. The business should have a consistent operating history.

The business should have favorable long-term prospects. It should have high profit margins. It should have a high and sustainable return on equity. Management should be candid. It should be rational. You should be able to understand the business's owner's earnings. You should look at the institutional imperative of the business. You should be able to determine the value, and you should be able to buy the business at an attractive price and a margin of safety. Now, we're going to cover each one of these in relation to Coke.

So as for simple and understandable, Coca-Cola is just a beautiful business because it's just not overly complicated. They sell the syrups to bottlers and retailers who in turn sell them to their customers. Now the margins, as I've already said, are very high on the concentrate business and not overly capital intensive.

So moving to consistent operating history, Coca-Cola obviously had been around since 1886 and they'd continued growing and chugging along that entire time. Now, just to show you how far the business had come, it had sold only nine drinks a day when Coke was first formulated. In 1899, the company had sold 250 gallons of their syrup a year. And today they serve 2.2 billion servings a day.

So it's quite clear that Coca-Cola had succeeded in growing its business very well over 130 years. Now, looking at favorable long-term prospects, shortly after it was reported that Buffett had taken a stake in Coke, a reporter asked him why he decided to purchase Coke now. And here's what Buffett said. So he said, let's say you were going away for 10 years and that you wanted to make one investment and you knew everything that you know now, but you couldn't change it while you were gone.

what would you think about? Of course, the business would have to be simple and understandable. Of course, the business would have to have demonstrated a great deal of business consistency over the year. And of course, the long-term prospects would have to be favorable. If I came up with anything in terms of certainty where I knew the market was going to grow, where I knew the leader was going to be the leader, I mean worldwide, and where I knew there would be a big unit growth, I just don't know anything like Coke.

I'd be relatively sure that when I came back, they would be doing a hell of a lot more business than they do now. Buffett also came to appreciate many initiatives that Goizueta and Keogh brought into Coke. Buffett could see how Coke was strategizing for the future, looking at the right KPIs, had the right leader, and was making intelligent capital allocation decisions. These advantages just weren't available before Goizueta took over. It's interesting because Buffett has said,

I try to buy stocks and businesses that are so wonderful that an idiot can run them because sooner or later, one will. And I think this is interesting specifically because before Goizueta, Coca-Cola's operations just had not been doing very, very well. And that just goes to show you that even a wonderful business like Coca-Cola can theoretically be derailed, at least for a time, by management making poor decisions. And I think that's really, really important to remember because

I think it just goes to show you that there's not really a business that's so good that an idiot can really run it. I mean, obviously, Warren likes this as a mental model, but I think just knowing what I know now about Coke and how good of a business it is, it's really hard for me to understand why it went through this period where it just didn't do very well. So the next area that Warren looks at is high profit margins. Now, Coca-Cola was a solid company and it was profitable for many years before Buffett took a position.

But the margins had actually been pretty volatile there before Goizueta came in and stabilized things. So in 1973, operating margins were 18%. By 1980, those margins dropped to just 13%. After Goizueta's first year CEO, he increased them to 14%. And when Buffett bought shares in Coke, margins were at 19%. Now, just as rising capital efficiency denotes a moat, rising margins do as well.

The beauty of increasing profit margins is that they mean that a business can grow its top line at a lower rate while increasing profits at a higher rate. I just love these setups because they're incredibly valuable when they occur slowly, but surely over long periods of time. So the next tenant that Buffett looks for is high and sustainable returns on equity.

So depending on the business model, you can interchangeably use return on equity or return on invested capital. Since Buffett preferred businesses with no debt, ROIC and ROE tend to be pretty similar numbers. ROE is just net income divided by shareholders' equity.

Now, the beauty of ROE comes into play when discussing business quality. There are two big bonuses to having a high and sustainable ROE. If you're a low growth company like Coke is today, having a high ROE means the business will continue to gush cash, reinvest some of that cash into the business while paying a nice dividend, and probably even having some extra cash left over for buybacks. These investments can continue to earn reasonable total shareholder returns for a decent amount of time into the future.

Now, the high ROE play that I personally find more interesting are when the company has no reason to use the cash on dividends or buybacks because the business can just plow everything back into the company. This means the business will earn a return equal to its ROE. So let's just say a business has an ROE of about 30% and the per share earnings are about $1.

So if it puts all earnings back into the business the following year, then the per share earnings will be $1.30. And when you can compound this for multiple years, the gains in per share earnings become just staggering. While Coke wasn't putting all of its cash back into the company, Goizueta understood capital allocation well enough to stop growing the dividend in terms of payout ratio so he could put more money back into Coke. And he did an incredible job. His capital allocation initially paid off and he grew Coke's ROE to boot.

During the 1970s, Coke's ROE was pretty high at 20%, but by 1988, when Buffett made the investment, Goizueta had brought that up to 31%. The next tenet that Buffett looks for is candid management. Now, I think I kind of covered this already when discussing Goizueta. He was a very candid person about the company.

mistakes that he'd made. And he clearly outlined things such as initiatives that he would use to try and repair those mistakes. And I think he just did an exceptional job of turning Coke around once he took over. I think candor is just so important because if a manager is willing to hide something small or deflect blame elsewhere, it's a good signal that they're hiding things and that those things might be larger and more impactful things in the future. Now, the next tenant is rational management.

Goy Sueto was an incredibly rational capital allocator, as I think I've hammered home already. He realized Koch had better opportunities reinvesting money into the business, so he decreased the dividend payout ratio from 65% to 40%.

Once he realized that buying back his own stock was also an intelligent capital allocation decision, he also did that. Now, the whole buyback thing takes some nuance to understand. So Coke could have theoretically put all of its cash back into the business. But the problem is, is that very few business can actually do this successfully. And since Goizueta utilized EVA, he would not spend cash if an investment didn't earn returns above that threshold. So this means that you just can't invest all the cash back into the business

to keep the ROE high in Coke's case. So had he just dumped all the money in, he probably would have broken all of his EVA rules and that ROE also would have shrunk quite considerably. So I think the decision to allocate the money elsewhere was the next best step. Now, speaking of specifically when Goizueta did these repurchases, so these were in 1984, which was the first time he did it. And Coca-Cola shares were trading at a price to earnings ratio of around 15 at their lowest point for that year.

Now this indicates a yield of about 7%, which is decent for buybacks. Now the next tenant is to understand owner's earnings. So Buffett liked using owner's earnings to help him with his equity bond mental model. Owner's earnings are simply net income plus depreciation and amortization, plus or minus changes in working capital, minus maintenance capex. This number is generally higher than free cashflow because it retains growth capex, whereas free cashflow minuses all capex.

If we look at the growth in owner's earnings before and after Goizueta took over, it's really obvious that he was making a tremendous difference. So from 1973 to 1980, owner's earnings grew only 8% compounded annually. This was before Goizueta took over as CEO. But from 1981 to 1988, owner's earnings grew by 18% compounded annually. Now, if we compare the performance of the stock in those periods, we can see how an increase in the owner's earnings

affects the stock price. So from 1973 to 1982, the return of Coke's stock price was just 6% compounded annually. But from 1983 to 1992, the average annual return of the stock was 31%.

So if you can find a business that can compound its owner's earnings for a long period of time, you better hold onto it. Now, the next tenet here is understanding the institutional imperative. So many CEOs will just simply replicate the actions of other CEOs in their industry. In Goizueta's case, the age of the conglomerate was in full effect during his reign. So he mostly escaped partaking in it by divesting into Coke's wine and water business and avoiding investing in adjacent soft drink categories

like Pepsi had done, which was to invest into things like snacks and restaurants. Notice here how I said mostly. So Goizueta invested in one business that was completely outside of Coke's circle of competence. So there was a period of time when Goizueta felt Coke needed to diversify its profit streams. And a colleague had mentioned Columbia, the media business. Coke would end up buying Columbia in 1982 for about five times book value at around $700 million. Now, to be fair, I

I said this was a mistake, but in reality, it was actually a pretty big win for Coca-Cola. So Coca-Cola ended up divesting of Columbia for $3 billion in 1989. So on purchase price alone, this was a return of 22% compounded annually, which was a very, very impressive investment. So the next tenant here is determining value. Buffett's purchase of Coca-Cola was pretty deceptive to the market.

It was trading at a premium to the market regarding the PE ratio, regarding cashflow, and regarding book value. Plus the earnings yield was lower than that of shorter term bonds. So in looking at Coca-Cola through this lens, it was kind of hard to justify exactly why Buffett made this investment. The only way to really justify the investment compared to bonds was to factor in growth. So Robert Hagstrom goes over various scenarios in the Buffett way, and he suggests that

With future growth rates ranging between, say, 12% and 5% for the next decade, the business's intrinsic value was between $21 billion and $48 billion. Now, when we look at the market cap at that time, it was only around $15 billion. And the interesting part was that the estimate of these growth rates turned to be overly conservative because Coca-Cola's actual market cap in 1998, which was a decade after he bought it, was $84 billion. Robert Leonard :

Now, this just goes to show how much downside protection the Coca-Cola investment had.

And given how conservative the growth numbers were, Buffett just left tons of room to the upside, which is what eventually happened. Now, the last tenant here is to buy at attractive prices. I mentioned above that his valuation of Coca-Cola indicated that the shares were heavily undervalued. Using the numbers above, he bought Coca-Cola for a discount to intrinsic value of somewhere in the 25% to 70% range. So he was buying the business at a very, very large margin of safety. Now,

I want to examine the next part of Berkshire's Coke investment through the lens of Charlie Munger and a few of the mental models that he used to better understand the opportunity that Coke presented to them. Charlie has a wonderful write-up on Coca-Cola that I'll be sure to link in the description for this episode. In it, he discusses how he would take a business from just $2 million to $2 trillion over 150 years terminating in 2034.

So Charlie used five primary metamodels to help pitch this idea. Let's go over each one in a little more detail.

The first one is to decide which no-brainer decisions have to be made to achieve a specific goal. Charlie came up with two. So the first one was to make sure a trademark protects the brand. In this case, Coca-Cola. The reasoning was that a generic brand will just never scale as well as a wholesome brand like Coca-Cola was. And the second one is to ensure that you follow the correct growth strategy. Start small, grow.

and then expand. Koch did this by starting first in Atlanta, then expanding to the rest of the United States, and then to the rest of the world. Now, the second mental model that he used involved the use of basic math, and I mean very, very basic. So he would just look at a few key assumptions that would need to be made in the future for Koch to eventually be valued at $2 trillion. So the first assumption is world population.

So in order to understand what Coke would be worth in 2034, he wanted to understand how many people would be around in 2034. So Charlie thought 8 billion people sounded pretty reasonable. Now, as of April 2025, the population is actually 8.2 billion. So if Munger were still around today, he might be able to get a boost in his numbers based on this fact. From some of my research, the forecasted population for 2034 should be around 8.8 billion. So Charlie was directionally correct here. The second assumption is

is how many eight ounce beverages the average person consumes daily. He estimated that eight eight ounce beverages would be consumed on average per day. From here, he estimated how much of the world market Coca-Cola would capture. And he said that they could capture about half of it. Now of this number, Coca-Cola would take about 25% of that share. Then he just put those numbers together and he figured out that Coke could supply about 3 trillion eight ounce servings in 2034. Then he just...

applied a profit to each of those servings, which he said was around 4 cents, and he reached a profit number of about $117 billion. If you multiply that by 20, you get above $2 trillion. Now, as a side note to this math, Coca-Cola's market cap as of May 9th, 2025 is $304 billion. So in order for it to reach $2 trillion by 1934, the stock would need to compound at about 21%.

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That's shopify.com slash WSB. All right, back to the show. Now, there is obviously the case where dividends are going to decrease the rate at which the stock needs to compound in order to reach maybe some sort of value around $2 trillion, but I highly doubt it gets to that $2 trillion. Even a trillion seems maybe doable, but it would be tough. Now, the third metal model has to do with psychology.

we need to generate several psychological influences to create a Lollapalooza effect on customers so that they continue coming back for another 150 years to consume the exact same beverage. And this was no easy task, but Charlie went for it anyways. So he said that the drink needs sugar and caffeine, which will help stimulate consumers. It needs to be a cold beverage because it's easier to maintain that temperature. And it must be something that leaves little

to know aftertaste so that consumers can have more than one per day and still enjoy it. And finally, the taste needs to be so unique that customers can only replicate it by buying the exact same product again and again. Now, the psychological angle here comes in two forms, which he called operant conditioning and Pavlovian conditioning. So operant conditioning was served by making a beverage with the above mentioned factors.

This was important because it also meant the consumer would consume the drink worldwide and wouldn't be swayed to a different brand while say, traveling or maybe even moving to another continent. For Pavlovian conditioning, you'll probably think of the dogs whose mouths would water when a bell rang because they associated that with eating. Now in Coke's case, they need to have a drink associated with things that customers like and admire. This refers to proper marketing and keeping the brand's integrity as high as possible.

Now to add to the Pavlovian response, he layered on social proof. Using popular people such as athletes or actors would provide social proof to consumers of the advertising that they produced.

This would further strengthen the bond between Coke and its customers. Moving to the fourth metal model, Charlie mentioned something called autocatalysis. So autocatalysis means, in chemistry, a chemical reaction is said to be autocatalytic if one of the reaction products is also a catalyst for the same reaction. Many forms of autocatalysis are recognized. For Coke, the reaction involved just two things, which was the syrup and the distribution.

As long as the syrup could be supplied to the bottlers, a reaction would take place to allow a never-ending stream of products to be available to all of Coke's customers. The syrup part was pretty easy, but the distribution part would need to be solved by having worldwide bottlers who could mix the syrup to get the end product and then just sell that to customers. The final metamodel that was classic Munger that he talked about here was to invert.

So when Charlie used inversion on a specific company, he was kind of thinking about how to destroy the idea. And he came up with a few keys. The first one is that the beverage needs a strong aftertaste, which is going to prevent consumers from having additional daily servings. The second is that the product should be easy to replicate while having a weak trademark that competitors can easily attack. The third is that the product should have poor quality control and poor presentation. And fourth, that people inside of the company should mess around with the flavor to improve it

even though they have a viable product. So this whole thought experiment is very good. I will say after learning more and more about Coke, there's probably a lot of hindsight bias here. It becomes easier to see what Coke did right versus what it did wrong after the fact. If we use Charlie's metal model, I think it's clear that you can make a winning beverage like Coke. But the real question is, could Charlie have thought of this exact scenario in 1886 before Coca-Cola was formulated? And I'll leave that for you to decide.

The last point that Charlie discusses in his talk is a new Coke fiasco, which is something that I want to focus on now. I mentioned just there that the fourth way that he saw that you could mess up Coca-Cola was to mess around with the flavor, and that's exactly what Coke ended up doing here. So in 1985, Goizueta made his biggest blunder as the CEO of Coca-Cola. He decided to mess with the recipe that had worked so well for nearly 100 years and pull the original recipe off the shelves to avoid cannibalizing the two flavors.

But let's go a little bit more into the backstory of this because he thought a change was necessary for some good reasons. First off, during this time, Pepsi was starting to steal more of Coke's market share. Additionally,

Since Goizueta was a chemical engineer, he had been taking steps to develop a new flavor that was now beating the classic recipe in blind taste tests. Now, in these blind taste tests, New Coke beat out both Pepsi and Coca-Cola Classic. To validate the test, he hired more than one firm to run them, and they found similar results. Now, oddly enough, when...

They surveyed a few focus groups to ask what they thought about the prospect of Coca-Cola Classic being pulled from the shelves. The feedback was very, very negative, as in people wanted to keep their Coca-Cola, the classic version. Now, I think this plays very well into what Munger discussed concerning the goodwill and trust that Coca-Cola had built with its customer base. Their consumers knew what to expect from Coke, and they just did not want the brand to be pulled off the shelves because of their connection with it.

I won't go into some of the focus groups responses as they're full of expletives, but just know that people were very, very passionate about Coca-Cola.

Now, during the lead up to New Coke, Coca-Cola had a couple of problems. It had issues with bottlers, which actually forced Coke to get into the bottling business, which they hadn't been beforehand. Competition was also fierce, and Coke had pricing power on its syrup that bottlers had to accept as part of the business. As a result of their market share going down to Pepsi, Coke also had to quadruple its marketing spend, and bottlers, again, were punished for this indirectly.

because they had to contribute their share to the marketing expense, which further compressed their margins. And then on top of all this, some Coke analysts believe that Coke's brand was just aging as other new product lines were released to the market. So Pepsi had Michael Jackson on its ads, who was considered new, and Coke was kind of lagging in the advertising department.

So there were just many, many different forces at play that were acting to pressure Goizueta into making drastic moves to help improve Coca-Cola's fortune. Once new Coke was released, several more problems actually arose. So David Greisling in I'd Like to Buy the World of Coke wrote, Goizueta's unwillingness to level on the taste issue became the core of the outrage that would develop over Coke's new formula. Goizueta realized later that if he had simply announced that the formula was better than Pepsi,

The public and press would have taken up the line and launched a series of challenge-style inquiries. And Stout's research clearly showed that New Coke should trounce Pepsi. Instead, by burying Coke's motivations, Goizueta unwittingly opened a second front in the Cola Wars. Instead of competing against Pepsi, as it was designed to do, New Coke wound up competing against the memory of the sainted original formula.

That became the issue and we created it, Goizueta confessed. Now, it's interesting to think about what would have happened if Coke had released New Coke as just an additional product line. Since New Coke was perceived as a replacement rather than another drink such as, you know, Cherry Cola or Diet Cola, it very well might still be on the shelves today had it been positioned differently. So here's an excerpt from the same book. So just to give you some backstory, this was when Goizueta was asked about the flavor differences in New Coke versus Coca-Cola Classic.

So a reporter asked Goizueta if he planned to reformulate Diet Coke if New Coke proved successful. No, and I don't assume that it is a success. It is a success, Goizueta harrumphed. On the way out of the theater, reporters tasted New Coke that had sat warming in paper cups on tables during the press conference. Many visibly grimaced, and some even spit the stuff out of their mouths. So once New Coke was released,

The negative calls just began flooding their hotline, exceeding 1,000 per day. People were also writing letters to Coke telling them their true feelings about the switch away from that classic taste. One letter was, "It is absolutely terrible. You should be ashamed to put the Coke name on it." Another one wrote, "I don't think I would be more upset if you were to burn the flag in our yard." So clearly, this change targeted just visceral emotions inside of many of their customers.

But as I hope I've illuminated in this episode, Goizueta was focused on one thing, which was creating shareholder value. If the news was bad from a few select customers but the economics were good, then he probably would have considered New Coke a success. But as you can probably guess, this wasn't the case.

So one of Coke's bottlers in the South said that the sales had plummeted after the release of New Coke and that he knew that it was a disaster after only 10 days. Bottlers demanded that the classic syrup be distributed back to their warehouses, even though they would have to eat a loss on the New Coke syrup. But they just didn't care, as he knew sales would normalize once the classic formula returned. This story is such a good representation of what Coke stood for.

Its brand was strong, and people fully associated a very specific taste with that brand. It was also seen as a cultural icon, as you can see from the person's response about burning their flag. It also shows how resilient the Coca-Cola brand is.

They overcame this debacle and carried on in pretty short order, specifically because the brand was so strong and entrenched in their customers' minds. Now I'll leave this section with an excerpt from Greisling's book. The world's most successful marketing company had misread its customers and risked the future of the world's most successful brand. But the salvation of Goizueta and his management team was the strength of the brand that they'd nearly destroyed.

Despite all that Goizueta & Co had done to fatally weaken the brand, Coca-Cola was strong enough to save itself and Goizueta too. Now let's observe some of Coca-Cola's additional competitive advantages that they built over multiple years. So there's two more that I want to go over, which is economies of scale and network effects.

Let's start here with economies of scale, because even though Coke is mostly known for its brand, its scale makes it nearly impossible for new entrants to the market to compete with. I see about five different scale advantages that Coke has that make it the behemoth that it is today. So I'll take you through a competitor's obstacles in terms of both of these competitive advantages. So to do this, we're going to imagine that we want to create a global soft drink brand. I'm going to say that I'm the CEO of this new brand, and we're going to call it

Eco C, which is just Coke spelled backwards.

We have operations in only the US right now, but the problem is that we simply can't get our drinks outside of the US because we need to both fund and open new bottling operations. We can't get deals with third-party bottlers yet because our product is just so unknown and the bottlers don't know if they'll get a good return by partnering with us. Sure, we could open a bottler halfway around the world, but then we would have to deal with how we'd go about doing just that in a country that we lack competence in.

Now, to get ballers interested in doing business with us, we'd have to spend money on advertising so that more customers know who we are.

However, ECO-C has only existed for five years. And while we turn a small profit and we're growing, we can only afford a few million dollars in advertising. Coke spent 5 billion on advertising last year, and we'd have trouble reaching just 1% of that spend. Now, we have taken some market share because we are small in the US where we're based, but our margins are just nowhere close to Coke. ECO-C has to spend CapEx on ballers,

Because that's the only way we can get our products to a few selected geographies in the US. Coke's operating margins in 2024 were about 21%.

Eco-C's are about 4%. Now suppose Eco-C could divest its entire bottling business and focus exclusively on just the concentrates and the syrup. In that case, perhaps we'd be able to meet or exceed Coke's operating margins, but it would still probably be nearly impossible because we just have no hope of ever being as recognized of a brand as Coca-Cola is. Now, the next problem relates to the concentrate only part of the business and the unit economics of it. So Coca-Cola

has to procure large volumes of high fructose corn syrup to get its syrup to its bottlers. Additionally, Coke serves 2.2 billion servings per day, meaning that it needs to have a lot of high fructose corn syrup and it has to take care of packaging all of that as well. Now, there's just no chance that a small competitor like Eco-C would be able to buy similar volumes of either of those inputs at the same unit volume as Coke. And then finally,

Coke can continue improving its bottlers and improving their operations, helping them with decreasing their margins. Eco-C can barely afford to open new ones. So the efficiency that Coke has and its ability to improve that efficiency will be just very hard for us at Eco-C to compete with. Now, Coke doesn't disclose its research and development spending, but we can probably estimate that it's a small part of the revenue.

Let's assume that it's just half a percent of revenue that they spend on R&D. Now, even with that number, that still comes to $230 million.

Therefore, it would be just incredibly challenging and pretty much impossible for Ecosy to even improve its bottling operating efficiencies through R&D spend. Now, let's imagine that we fast forward five years and Ecosy is a bigger company. It's done this by partnering with Pepsi, which is a strategy that Celsius has already taken. So Ecosy learned a ton from the deal between Pepsi and Celsius and has decided to just clone it as close as possible.

So we at EcoSea accept capital from Pepsi to help build out EcoSea. And in exchange, we're going to give Pepsi convertible preferred stock. And we'll also allow Pepsi to have some board representation for our company as well. Now we're more prepared to play with the big guys. But from here, there's going to be another problem that's going to arise. Yes, Pepsi can definitely help us get our product onto the shelves where customers are going to see it.

But unfortunately, what we notice is that it's getting harder and harder to find new grocery stores, convenience stores, and gas stations to carry our product. Now, when we send out salespeople to try to convince everyone, whether that's just shop owners to multinational corporations to open up spaces in their fridges to carry Ecosi, we're meeting a ton of resistance. And the reason is simple, and it's network effects. So the more money that Coke puts into advertising, the more people know the brand.

That means when someone goes out on, let's say a hot day and needs a beverage,

they're more likely to desire a Coca-Cola product. If they go to a convenience store that doesn't have Coke, but has, let's say, Eco C, they're simply going to go to the C store's competitor across the street and get themselves a Coke. Therefore, the store that's maybe carrying only Eco C will need to open up space to carry Coke if it wants to continue selling soft drinks. Then on top of the soft drink only sales, there's still crossover. When people go into a convenience store or a gas station to buy a drink, they're also often buying food.

So if you're losing soft drink sales, that also means that you're probably going to be losing out on snack and food sales as well. So I think here with this example, I think you can tell that Ecosy has a very steep hill to climb here regarding scale and network effects. Coke has also been in business for nearly 140 years. So they know what they're doing, have large amounts of trust built up with suppliers, customers, and bottlers, and can also put pressure on all these groups to create the most favorable terms for Coca-Cola.

And this is an advantage that a smaller incumbent business like Eco-C just wouldn't have. Now, to conclude today's episode, I want to discuss my opinions on Coke as an investment in very broad terms. I know that I'm at a very particular point in life where I'm in wealth building mode. That means that I want investments that resonate more with building wealth rather than purely wealth preservation. Now, I think Coca-Cola fits nicely into the second category.

If we look at the last 10 years of Coke's share price and operating history. First, as a side, Coke is an exceptional business. As I've highlighted today, it's simply one of the best businesses out there because competitors have attacked it for decades and it still manages to come out on top. And I have no arguments with investors who say Coke is an exceptional business because it is. But the stock's return looks a lot less exceptional over the last 10 years. In the last 10 years, the stock's capital appreciation has compounded at only 5.5%.

Yes, you can add a 3% dividend, bringing the total to about 8.5%. Coca-Cola's stock returns are below the S&P 500 compounded annual rate of 12% over that same time period. Now, you can make the argument that Coke is something like a Berkshire Hathaway, just an exceptional business that might not outperform the index, but you're happy to have it in your portfolio because you admire the company, the industry that it's in, and you know that it's just a very resilient company that's still going to be chugging around here for decades to come.

I can see the argument for that. I know many investors want great businesses that they can easily understand in their portfolios, even if it's maybe a little bit below their hurdle rates. Now, I don't take the strategy personally, but I can see its validity. Certain businesses are much closer to my hurdle rates in terms of my expected compounded annual growth rates compared to others that might be higher. So by the same rationale, I should probably sell those positions for positions with higher compounded annual growth rates

as that would be the rational decision if I were attempting to maximize my returns. But this is where the art part of investing comes in. Investors need positions that will help them sleep at night. If you have 15 positions and all 15 of them make you worried 24/7, your quality of life is just going to suffer. Robert Leonard :

But if you have, let's say 15 positions, 10 of them barely require much thought or thinking about because they're just such good businesses. While five of them maybe sometimes keep you thinking, but don't do it 24 seven. And your quality of life is obviously going to be a lot better than that first scenario. I have certain businesses that are likely to grow faster than others, but many of these businesses that might deliver lower returns are positions in which I built a ton of conviction in and know them very, very well after holding them for long periods of time.

So even though it could make sense for me to sell them and buy more of the faster growing ones, it makes investing just much more enjoyable for me to just keep them. I don't have to worry much and they just keep producing for me and I can enjoy the steady gains that they'll deliver. During Monish Pabrai's chat in Omaha in 2025 during the Berkshire GM, he gave an excellent presentation titled, You Only Have to Get Rich Once.

In part of the presentation, he discussed why holding great businesses is so important. He mentions that even if you keep just one business, Walmart in this case, you can get incredible returns, even if everything else in the portfolio doesn't work out. So people like Warren Buffett might look at something like Coke and see a wonderful business that will continue to grow at moderate rates. While it won't grow as fast as something like Apple, Buffett knows and understands Coke at such a deep level that he's developed a sort of comfort with it.

When you get to this stage of investing, it becomes just easier to hold the business. I don't think anything is wrong with this strategy as long as you don't allow the investment to be a massive drag on your performance over a long period of time. So if I were retired and wanted a business that would give me a nice dividend for the foreseeable future and some modest capital gains, perhaps Coke would interest me. Or even if your goal is just to match the index with a few businesses that you really admire and understand, I can see how Coke might be an interesting investment.

For now, I'll stick to admiring Coke from afar and learning from its strengths and weaknesses. That's all I have for you today. If you'd like to interact with me on Twitter, please follow me at IrrationalMRKTS or on LinkedIn under Kyle Grief.

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