In the late 1980s, Warren Buffett asked the Securities & Exchange Commission (SEC) for special permission not to disclose his trades for a year, on the grounds that his reputation as an investor was so formidable that news of his new investment would move markets. The SEC obliged, and when Berkshire Hathaway shareholders showed up at their annual meeting in 1988, they had no idea that Buffett had bought 14 million shares of a company he was newly bullish on. There was only one clue as to what he had done. Instead of his customary Pepsi dosed with cherry syrup, he was swigging Coca-Cola.
For years, Buffett had had his eye on Coca-Cola (KO 0.43%), according to his biographer Alice Schroeder. But the stock had been too expensive for him to buy, until a pricing war with Pepsi dragged the stock down to $38 per share. Suddenly, Buffett was enticed to invest $600 million in the company, though he preferred to add to his position over the years rather than buy all at once. By the time he bought his last share in 1994, Berkshire would have exactly 400 million shares acquired at a cost of $1.3 billion.
Adjusting for stock splits, Buffett established his position at an average entry point of $3.25 per share. Not only has Coca-Cola's share price risen by more than 2,000% since, but Berkshire's position generates $816 million in dividend income each year. Not bad for an initial $1.3 billion position.
It's one of his greatest investments, but those gains, alas, are in the past. Buffett has never sold a single share of Coca-Cola, but since 1994 he hasn't bought an more, either. So, decades later, is Coca-Cola still a buy?
The "secret sauce" to Berkshire's 3,787,464% return
In his 2022 letter to shareholders, Buffett highlighted Coca-Cola, along with the financial services company American Express, as examples of "the secret sauce" driving Berkshire's returns of 3,787,464% since 1965.
Buffett pointed to the $702 million in dividends that Berkshire received in 2022 from Coca-Cola shares, a nearly 50% yield on the $1.3 billion purchase. And he called its dividend checks "highly likely to grow." Sure enough, that income stream has grown to $816 million three years later.
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In February, the company announced its 63rd annual dividend increase. Its status as a Dividend King is hard-won, and management is no doubt bent on announcing another dividend hike next February.
That's significant because the stock already pays a yield of 2.9%, well above the S&P 500 average of 1.14%. And while management doesn't issue dividend guidance, there are clues that it could be sizeable.
As of last quarter, Coca-Cola grew earnings per share by 30%, and cash flow from operating activities (CFO) totaled $3.65 billion.
CFO is the cash left over after a company pays employees, business expenses, and otherwise keeps the lights on. It's what's left over to pay for dividends, share buybacks, or mergers and acquisitions. With Coca-Cola's 4.3 billion shares outstanding, its quarterly dividend of $0.51 per share costs the company $2.19 billion to cover, or 60% of its CFO.
For such a big and established company, having 40% of CFO left over after paying dividends is substantial breathing room, especially since the company is growing margins.
The bottom line
Coca-Cola is highly likely to continue growing its dividends in the years to come, meeting Buffett's expectations as a cash-gushing machine.
But if capital appreciation rather than income is your objective, there are better options. Coca-Cola's share price has risen 55% in the last decade, compared to 223% for the S&P 500. For such an established company that already dominates its sector, Coca-Cola is no longer a growth stock. That said, its above-average dividend yield, combined with likely future payout hikes, could make it a formidable income machine for investors who act today. If income is your priority, Coca-Cola is a sensible investment.