Apple, Coke, Tesla, WorldCom & Warren Buffett: What Can We Learn?

April. Busy month. Let’s use numbers and history to make a powerful point with simple pictures.

The cranberry bars show Apple’s price to sales (P/S) ratio by year. You can see AAPL’s valuation ballooned from 3x sales in 2014 to 7x sales today. The navy-blue bars show Apple’s market cap from 2014 through today.

The light blue bars show what the market cap would be if Apple’s valuation, or price-to-sales multiple, had been held constant at its 2014 level of 3x sales. Look at the difference between the last navy-blue bar and the last light blue bar on the far right.

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At 7x sales Apple’s market cap is nearly $3 trillion. If we held the multiple at 3x sales like in 2014, it would only be worth $1.1 trillion. So multiple expansion accounts for over $1.5 trillion in market cap.

KCR has written a great deal over the last few years about the profound effect of multiple expansion on tech, Tesla and other mega-cap darlings. KCR is unapologetic for its relentless adhesion to the empirical truth: what you pay matters. Even for blue-chip companies.

Our team also recognizes that the relentless bubble in indexing and the intoxicating levitation of a collection of large-cap stocks can make something simple – like “what you pay matters” – painful. How painful? Under certain speculative conditions, even the greatest investors in the world can lose sight of it. Here is Warren Buffett in his 2003 letter to shareholders, emphasis ours:

We bought some Wells Fargo shares last year. Otherwise, among our six largest holdings, we last changed our position in Coca-Cola in 1994, American Express in 1998, Gillette in 1989, Washington Post in 1973, and Moody’s in 2000. Brokers don’t love us.

We are neither enthusiastic nor negative about the portfolio we hold. We own pieces of excellent businesses – all of which had good gains in intrinsic value last year – but their current prices reflect their excellence. The unpleasant corollary to this conclusion is that I made a big mistake in not selling several of our larger holdings during The Great Bubble. If these stocks are fully priced now, you may wonder what I was thinking four years ago when their intrinsic value was lower and their prices far higher. So do I.

One of the greatest investors of all time. Apologizing for holding Coca-Cola in the great growth bubble of the late 1990s. Several of KCR’s staffers recall marveling at Mr. Buffett taking time to acknowledge this “error” in judgment on his part. After all, by the late 1990s, Mr. Buffett was being ruthlessly pilloried for losing his touch.

His refusal to invest in new-age tech stocks and companies reinventing legacy industries had left Berkshire’s shares lagging the S&P 500. Badly. Worse, these innovative companies were hardly secrets.

They were easy to find. Easier to buy. Their CEOs were often famous.

The President of the United States called Enron’s chairman “Kenny Boy.” WorldCom CEO Bernard Ebbers was on the cover of BusinessWeek magazine.[i] In 1998, Wired Magazines “The Wired 25” led out with:

Life is short. Especially when you’re determined to break all the rules. In any age, there are a few people who give the rest of us something we can truly aspire to – and never more so than today.”[ii]

Mr. Ebbers was third on Wired’s list with the magazine’s homage to his greatness, stating simply, “It’s all over. Bernard Ebbers of WorldCom has won.” In a moment of sheer madness where society openly hailed “rule breakers” and swept fortunes into the hands of corporate titans who were little more than attention-seeking crooks, we believe that if Mr. Buffett’s biggest error was holding onto Coca-Cola, it is hardly worth mentioning.

But we can learn from this. Below we replicated the Apple chart on page one but used Coca-Cola into the peak of the 1990s growth bubble. Navy blue bars are the progression of Coke’s actual market cap. It peaked in 1998. The light blue bars are what Coca-Cola’s market cap would have been if the price-to-sales multiple had simply been held constant at its starting level in 1988. Remarkably similar to Apple today, no?

How did investors come to believe a soda company could merit such a massive expansion in valuation? Inefficient markets and extrapolation bias, of course.