A clear investment philosophy is a requirement for successful investment decisions.
The cornerstones of investment philosophy include the decision-making process, a long-term orientation and the ability to assess the probability of success of a particular investment idea. The surest path to satisfactory investment returns is a quality decision-making process, followed by disciplined application of the decision making process over the long-term.
At AXIAM, we deeply understand the businesses we own and their long-term prospects. We have used Coca-Cola as an example to illustrate these practical, strategic steps we go through when we consider and investment.
Investment Decision Step 1: The company owns brands
Our first step is to consider whether the company we want to invest in owns strong, global brands. Coca-Cola satisfies this criterion.
The Coca-Cola Company has built a universally defensible trademark that is one of the most recognised brands in the world. We use many sources of brand research to identify leading brands, including the BrandZ Report published annually by WPP.
Coca-Cola Brand Value
The 2016 BrandZ Report ranks Coca-Cola as the world’s top soft drink brand by a wide margin. They are leaders in “Non-Alcoholic Ready to Drink” category.
The brand contribution score of 5 denotes the power of the Coca-Cola brand. Brand Contribution measures the influence of brand alone on earnings, on a scale of 1 (lowest) to 5(highest).
If we look a little closer, the picture becomes more striking. Of the top 15 soft drink brands in the world, Coca-Cola owns 7.
| Brand Owner | Brand Value | Share |
|---|---|---|
| Coca-Cola | 100,434 | 65% |
| Pepsico | 22,790 | 15% |
| Nestle | 11,694 | 8% |
| Red Bull | 11,667 | 8% |
| Unilever | 8,554 | 6% |
| Grand Total | 155,139 | 100% |
Coca-Cola’s brands account for 65% of the leading global non-alcoholic beverage brands combined, a staggering and hard to replicate achievement.
Building the Coca-Cola brand
Coca-Cola continues to invest in the brand to take advantage of new ways to reach consumers. For the Year Ended December 31, 2015, Coca-Cola spent $3,976 billion on advertising and other demand generating activity. This investment in brand building represents just over 11% of their gross revenue for the year. Any company that can afford to spend between 5 and 10% on advertising is significant. Coca-Cola exceeds this benchmark and manages to make their brand presence felt in over 200 countries.
Coca-Cola Distribution
Coca-Cola is available in over 200 countries and has the largest beverage distribution system in the world.
Investment Decision Step 2: The company pays dividends
We want to earn income (dividends) from the shares we own. When we reinvest this income, it unlocks the power of compounding which has a significant impact on our investment returns and our ability to earn higher levels of income in the future. Read our compounding dividend income blog for more information.
Coca-Cola has paid a dividend every quarter since 1920, and they have increased the annual dividend payout every year for 54 years. This track record gives a good indication that they are likely to continue to pay out dividends at an increasing rate in the future. The graph below illustrates the growth of the Coca-Cola dividend payout over the last 20 years.
Investment Decision Step 3: Longevity
Our investment horizon is a long term one, so we want to invest in companies that will be around for a long time and are likely to grow over that period. We look at the following factors as indicators of whether a company meets the longevity criteria:
- Do the company’s products fulfil a basic human need? If they provide for needs like food, water (liquid), health and energy, they are more likely to be around over the long term as there is an ongoing demand for their products. Read more in our blog on fundamental human needs.
- Will the company benefit from a growing global population? As the world population grows, will the need for the product grow?
If we apply these criteria to Coca-Cola, we can see that their provision of non-alcoholic beverages meets an ongoing human need for fluid. As the world population grows and their basic level of income increases they will buy a universally safe and tasty drink to meet this basic need for liquid refreshment.
As the United Nations points out below the world population is growing:
This continued population growth means there will be more people on the planet who require daily fluid intake to survive.
Charlie Munger sums it as follows:
Investment Decision Step 4: Attractive to the people with growing disposable income
Are the products that are produced by the companies that we consider buying attractive to people with growing disposable income? As Charlie Munger put it, as a person’s disposable income increases;
In other words, the products that Coca-Cola produces become more attractive as disposable incomes increase and consumers seek more variety in the beverages they ingest.
Investment Decision Step 5: Low Debt
If companies own strong brands in growing markets, they are likely to have cash reserves allowing them to invest in research and development into new products, grow and reinvent their existing brands.
Companies with little debt have lower financing and interest costs, and more importantly, they are less vulnerable to changes in the economy that could result in increased interest rates resulting in increased financing costs.
| FY 07 | FY 08 | FY 09 | FY 10 | FY 11 | FY 12 | FY 13 | FY 14 | FY 15 | FY 16 | FY 17 | |
|---|---|---|---|---|---|---|---|---|---|---|---|
| Debt/Equity | 0,15 | 0,14 | 0,2 | 0,45 | 0,43 | 0,45 | 0,58 | 0,63 | 1,11 | 1,29 | 1,29 |
While Coca-Cola has some debt, it needs to be viewed as a ratio of debt to equity. Looking at the Morningstar Financial Health Ratios (in the table above) over the last ten years Coca-Cola’s debt to equity ratio has slowly climbed from 0.15 to 1.29. This low level of debt equity means that Coca-Cola has a healthy amount of cash in relation to their debt.
Conclusion
Today’s consumer has higher disposable income than that of the previous generations, and as technology and productivity improve, disposable income is likely to continue to grow. This means there will be more people on the planet who need fluid daily, and these people will have increasing disposable income allowing them to afford to buy beverages that Coca-Cola makes available via its unmatched global distribution system! These facts ensure a long-term and slow changing market for non-alcoholic beverages.
At AXIAM, we buy shares in companies, regardless of their geography, that have great brands that are known, loved and used by people around the world daily. Sign up to our newsletter or follow us on Twitter to learn more about investment in the best global brands or contact our fund management team to invest.