On June 15, 1998, Coca-Cola, owner of the world’s most powerful brand, and one of the “Great all times” companies traded for $88.94 per share.
For long time, financial analysts recommend to keep a bulk of equity holdings in companies like Coca-Cola, which has high profit margins, high returns on capital invested, and a durable competitive advantage.
Owning such stock for many years is the surest, easiest, greatest way to get rich in stocks.
But anyone who bought Coke in late 1998 suffered from big losses because he ignored the timeless rule of wealthy and sophisticated investors.
What is this rule?
The rule is that the price you pay is the most important thing when it comes to investing.
If you pay a cheap price, you can make money in even the worst businesses.
If you pay an expensive price, you can lose money for long periods of time in even the best businesses.
Back in 1998, Coke’s earning per share was $1.43 and the price at the all-time high of $88.94, which means the price to earnings ratio (P/E) equals to 62 times. That’s crazy expensive.
Investors were accepting an “earnings yield” of about 1.6%. (the amount of earnings as a percentage of the price which means $1.43 in earnings, divided by an $88.94, and you get 0.016… or 1.6%).
It’s much similar to a situation where you buy a $100,000 house that you can rent out for about $1,600 a year, or $133 a month. It would take you 62 years to get your money back out of that investment. And only a fool would pay you $100,000 again to take the house off your hands.
When you accept terms like that, you’re almost guaranteed to lose money in stocks.
And that’s exactly what happened to investors who bought Coke at the wrong time. In less than three months, it was down more than 30% and five years later, it was down 50%.
Even 13 years later, if you are counting dividends, those investors hadn’t made a dime in Coke, which is one of the world’s greatest companies.
And most importantly, nothing was wrong about Coke’s business during that time. It was still one of the world’s most powerful brands with strong competitive advantage and continuous dividends distribution.
The losses incurred for those who bought in 1998 were directly the result of paying a crazy expensive high price for the stock.
The same thing happened to investors who bought software giant Microsoft (MSFT) in 1999. It took more than 15 years for investors to compensate their losses, because they paid the wrong price.
The stock was offering roughly a 2.4% earnings yield. At that rate, it would take you 42 years to get your money back.
As investor you should target rather a “payback period” of 12 years or less, which means getting an earnings yield of 8% to 10% (or more).
Intelligent investors know that the price you pay is everything when it comes to making money in stocks specifically and in any other financial asset generally.
Always remember, you can lose money even in the world’s greatest businesses if you pay the wrong.