QUALIPORT
Buying At Buffett Prices

By Maynard Paton (TMFMayn)
February 10, 2003

This bear market continues to produce all sorts of investment opportunities. Such is the investor despondency, Fools now have the chance to pick up two of Warren Buffett's favourite stocks -- Coca-Cola (NYSE: KO) and American Express (NYSE: AXP) -- at valuations similar to those seen when the great man himself last bought.

Coca-Cola

Take from Berkshire Hathaway (NYSE: BRK.A) annual reports, this is Buffett's record of buying Coke:

Year    Shares bought*    Price*       Cost
                           ($)         ($)

1988     113,376,000       5.23     592,540,000
1989      73,424,000       5.88     431,380,000
1994      13,200,000      20.83     274,968,000

(*Adjusted for stock splits)

At $39.63 a share, the holding is currently worth $7.9b. The next table shows the forward price to earnings (P/E) ratio and dividend yield of Coke in the years Buffett invested:

Year     Price    Earnings    Dividend      P/E  Dividend Yield
           ($)    per share   per share             (%)
                     ($)         (%)

1988      5.23      0.36        0.15       14.5     2.9
1989      5.88      0.42        0.17       14.0     2.9
1994     20.83      0.99        0.39       21.0     1.9

Now      39.63      1.77*       0.80*      22.4     2.0
                    1.95**      0.84**     20.3     2.1

(*Estimates for 2002, results due Feb. 12th; **Estimates for 2003)

At the moment, Coke is some way off the P/E of 14-15 seen when Buffett bought the majority of his holding. But a $275m stake was purchased during 1994 when the prospective P/E was 21. Based on estimates for 2002 and 2003, Coke shares presently trade on a similar valuation.

(Incidentally, at the 1998 Berkshire Hathaway annual general meeting, Buffett was asked if there was a price at which it would become inappropriate for Coke to buy back its shares. From Outstanding Investor Digest, Buffett responded:

"Well, certainly 40 times earnings sounds like a very high price to pay when you buy back stock... However, I would say this: Coca-Cola's been around what -- 112 years now? And there are very few times in those 112 years, if any, when it would NOT have been smart for Coca-Cola to have been repurchasing its shares.

In my view, among businesses I can understand, Coca-Cola is probably the best large business in the world. I mean it is a fantastic business.

We love it when Coke repurchases shares and our interest goes up... All I can tell you is I approve of Coke repurchasing its shares. I'd a lot rather have 'em repurchasing shares at 15 times earnings. But while I've looked at other ways to use capital, I still think it's a very good use of capital. And maybe the day will come when they can buy their shares back at 20 times earnings. And if they can, I hope that they'll go out, borrow a lot of money and buy a TON of it back at those prices.")

American Express

This is Buffett's record of buying American Express:

Year    Shares bought*    Price*       Cost
                           ($)         ($)

1994      83,279,823       8.69     723,919,000
1995      65,090,877      10.27     668,781,000
1998       3,240,000      23.86      77,300,000

(*Adjusted for stock splits)

At $33.74 a share, the holding is presently worth $5.1b. The next table shows the forward P/E ratio and dividend yield at the times Buffett bought:

Year     Price    Earnings    Dividend      P/E  Dividend Yield
           ($)    per share   per share             (%)
                     ($)         (%)

1994      8.69      0.89        0.30        9.8     3.5
1995     10.27      1.04        0.30        9.9     2.9
1998     23.86      1.59        0.30       15.0     1.3

Now      33.74      2.25*       0.32*      15.0     2.0
                    2.53**      0.32**     13.3     2.0

(*Estimates for 2003; **Estimates for 2004)

Like Coke, American Express is also some way off the P/E (of 9-10) witnessed when Buffett bought most of his holding. However, a $77m top-up was made during 1998 when the prospective P/E was 15. Going on broker estimates for 2003, American Express shares presently trade on a comparable valuation.

Factors

Of course, there's more to consider than P/E ratios falling back to levels seen a few years ago:

* Coke and American Express may have experienced a slide in business quality during the intervening years. As such, a lower 'buy price' valuation may now be in order. A severe deterioration in quality would appear unlikely though, since Buffett still owns both stocks.

* Equity valuations relative to investment alternatives also have to be taken into account. For instance, when Buffett bought his first chunk of Coke, 30-year US Treasury bonds were yielding 9.0% versus Coke's then earnings yield of 7.1%. During 1994 when Buffett made his last purchase, 30-year Treasuries were yielding 7.9% versus a Coke earnings yield of 4.8%.  At the moment, 30-year US Treasuries yield 4.8%, the closest they've been to Coke's earning yield (presently 4.5%) for a long old while. On this basis at least, Coke shares appear relatively attractive.

Buffett's next Shareholder Letter, due to be published late February/early March, will reveal what -- if any -- common stock purchases he made during 2002.

The author wishes to express his thanks to Tode, a regular on Fool.com's Berkshire Hathaway discussion board