the value of a stock idea

The value of a stock idea can come from a combination of four sources:

1. How much money you put in the idea.
2. How cheap the stock is.
3. How fast the stock is compounding its value.
4. How long you own the stock.

The ideal stock would be a business quickly compounding its intrinsic value per share, which you are able to buy at a deep discount to intrinsic value, which you feel confident allocating a big chunk of your portfolio to and which you are going to hold for a very long time.

Take Buffett’s investment in Coca-Cola for example. This was considered a big bet by Berkshire. By my calculations, however (admittedly, very approximate based on the data I have), Buffett allocated perhaps just under 20% of his entire stock portfolio to Coca-Cola at the time he built the position. Despite putting just 20% of his portfolio into the stock in the late 1980s, however, Berkshire ended up not only with a position that today is worth about 13 times what he originally bought – the one position alone is also worth several times what Berkshire’s entire portfolio was when he made the Coke investment.

How did he do that?

Let’s look at the four ways to get the most out of a stock idea:

1. You can put a lot into the stock (Buffett put 20% of his portfolio into Coke).
2. You can hold the stock a long time (Buffett has now owned Coke for just under 30 years).
3. The stock can compound is intrinsic value at a high annual rate (Coca-Cola compounded EPS at about 11% a year for the first 25 years Buffett owned the stock).
4. You can buy the stock when it is cheap (the P/E on Coke went from 15 when Buffett bought it to 30 recently).

Coke is pretty close to a perfect example of some value coming from all four possible sources of getting the most out of an idea.