Turning $1M to $1B+: An Investing Masterclass from the Indian Warren Buffett (Mohnish Pabrai)

The opportunities that would truly make us wealthy are not going to come around every week. They'll come around every so often, and they come around at unpredictable times. But when they do come around, and when you do recognize it, you need to act very significantly and very quickly.

So, I haven't given this talk before, so to some extent, you're guinea pigs. Thank you for being the guinea pigs. It's somewhat different from a lot of other talks I've given. I've always felt that the best way to learn is to teach, and so quite frankly, one of the big reasons I wanted to put this together was to actually educate myself. Actually, I got quite an education in putting the talk together, and I think I'll get a little bit more of an education in the interaction today, so that'll be great.

The focus of the talk is really to appeal to a few different audiences. One is if you are considering a career as an investment manager or an investment analyst. I think the talk would be helpful in helping you figure out whether that is the path you want to go down. Even if you are a person who has some assets and some savings and trying to figure out how to invest those, I think the talk will add some value on that front as well.

Most of the material I'm going to present is plagiarized because I have no original ideas. You'll soon learn that. So, I'm actually going to be channeling a guy named Peter Kaufman, another guy named Charlie Munger, and a little bit of Warren Buffett thrown in. Peter is the author of "Poor Charlie's Almanack." Some of you might be familiar with that, and it's a wonderful book. I think it's one of my favorite books. He’s very close friends with Charlie Munger. I think one time he told Charlie Munger that, "You know, Charlie, you and Warren have been successful for three reasons."

Do you know what those three reasons are? Charlie told him, "No, Peter, why don't you enlighten me?" So, Peter said, "Well, the three reasons you guys have been so successful is that first, you're willing to be extremely patient. You guys are not in a hurry to do anything; you're willing to be very patient. The second is that you're willing to be very decisive. So when opportunity presents itself, you don't hesitate to act."

Munger has referred to this kind of like a man with a spear standing there waiting for a salmon to go by. He's got the spear ready, and he's perfectly happy waiting there for hours. Then, you know, a big juicy salmon goes by, and he spears it. So, you know, extreme patience coupled with extreme decisiveness.

The third trait is having no concerns about being different from the crowd. Doing whatever they feel makes sense, regardless of how the world looks at it, they don't really care about what people might say if they do something. What Peter said is that you really have to unpack that a little bit. When he says being patient, it's not about being in agony while being patient; it's being in bliss while being patient.

It should be a very natural trait for you to be very happy to watch paint dry. So if you're the kind of person who loves to watch paint dry, then the investing business is a very good one for you. The decisiveness again; you know, it shouldn't make you break out in sweats. But when you see every so often, you know, Charlie says that for each of us, the opportunities that would truly make us wealthy are not going to come around every week. They'll come around every so often, and they come around at unpredictable times. But when they do come around and you do recognize it, you need to act very significantly and very quickly.

That again is a second thing that a lot of people have issues with where they'll recognize something, and then they'll make a 2% bet. So that also is a second trait. The third one about being different is probably the hardest for humans. Humans are resistant to stepping away from the crowd. So having no concerns about how people think about you based on what actions you take is a very important trait. Having no stress about it.

So each of you can evaluate that for yourself in terms of whether those are, you know, does the glove fit, if you will? Does the glove fit with those traits? To some extent, I think there must be, at least most of it needs to be inborn. I think it would be a little bit difficult to take a high-speed trader and convert him into a model like that.

You need to have kind of a natural bias towards that in your personality. The other piece is, you know, how do you make investments? How do you know something's a great idea or not? I thought what I'd do is take the example of one investment that Warren Buffett and Charlie Munger made, which was the investment in Coca-Cola. I wanted to go through the models they used when they made this investment.

There was no spreadsheet ever created when they did the Coke investment. From then till today, it's been about almost 30 years since they made the investment. They have no analysts or associates or anyone who helps them. I don't even believe they made much in terms of notes when they made the investment, but they thought very deeply about it. For most investments, if you can't do the math in your head, then it should be an automatic pass.

So there was no DCF model run for Coke. There were no numbers-based models. I mean, they had some numbers in their mind, but I don't think they ever reduced them to paper. They did have, I think, and I may be missing some of them, but I think there were dozens upon dozens of models that they used in making the investment.

What happens is that when you have an overlay between models, that's when you get what Charlie Munger calls "lollapalooza effects." You know, 1 plus 1 becomes 11. So it's really kind of the interplay between the models that lead to kind of the "aha" moment and such. Charlie Munger had given a speech to a group that basically elected to be secret, told him not to disclose the name of the group that he gave that speech to.

After he gave the speech, where part of the speech covered the Coke investment, they told him it was a useless speech. They didn't appreciate it. I actually think it's one of his more brilliant speeches and actually gives you a window into how they think, so I think it's useful.

So anyway, the Coke investment that Berkshire made was made between 1988 and 1990, about a year period when they bought the stock. At the time, they invested about $1.3 billion into Coke. $1.3 billion at that time was approximately 1/4 of the book value of Berkshire Hathaway. They made a very significant bet. Think of an insurance company taking 1/4 of their equity into a single stock, and that's what they did at the time.

The last bit of Coke that Warren bought in 1990 was bought at about 25 times trailing earnings. So it wasn't cheap by traditional metrics that you might use. But on many fronts, they considered it a no-brainer. Obviously, they've now not touched that position for almost 30 years, and I don't think they're going to touch that position even well after Warren and Charlie are gone from the scene.

I don't think the Coke position is going to get touched at Berkshire for a very long time. So why do they make the investment, right? What went through their minds to make the investment? One of the things that Warren and Charlie have said is that if they had not invested in See's Candy, they would have never ever invested in Coke.

To understand the Coke investment, we should go back to the See's Candy investment because that'll give us some clues. In 1972, they bought See's Candy. How many of you are customers of See's? Have you ever had See's Candy? How many of you have never had See's Candy? We have a few unfortunate humans. Maybe you can, next time you're going through some airport, you know, get some peanut butter brittle. That might be a good start.

Anyway, so they bought See's in '72 for $25 million. The deal almost didn't happen because the family that was selling wanted $30 million for the company, and Warren was already choking at $25 million. He thought the $25 million price was really rich. The reason why Warren thought $25 million was rich was See's was a company that at the time was generating about $2 million a year in cash flow. They had $8 million in net book value, and the purchase price was $25 million.

So they were paying more than three times book value for the business. When the family said they wanted $30 million, Warren just said that, "Hey, at $25 million, I'm out of here. You can either take the $25 million or we'll walk." They were very grateful that the family didn't walk and sold them the business for $25 million.

Twelve years later, in 1984, See's was earning $13 million. So, in '72 when they bought it, it was making $2 million. In '84, 12 years later, it was making $13 million. The book value had gone from $8 million to $20 million, and the unit volume over that 12-year period had only gone up by about 2% a year on average.

If you look at the See's Candy purchase from 1972 and take it all the way till today, the unit volume growth of See's has been about approximately 2%. The number of pounds of candy they sell every year has gone up about 2% a year over the last, let's say, 45 years or so. But their earnings have gone up significantly more than that.

It's a private company; they don't disclose the numbers. I would guess that See's is probably approaching $100 million maybe somewhere in the $70 to $100 million, maybe even more than that, in terms of earnings per year at this point. California GDP from '72 till now has grown probably 5% or 6% a year.

So, See's did not keep up with California GDP growth over that period from a volume growth perspective. In fact, even the 2% volume growth that has come in has come in with square footage increase. Their retail space went up by approximately that number, which led to that growth.

Warren and Charlie say that the river of cash that came out of See's funded a zillion other things at Berkshire. If you ask them today, what is the value of See's to Berkshire, they probably couldn't even tell you, but it would be in the tens of billions. It would be very significant in terms of what it did.

If you were to ask them today that, you know, Charlie says that we were barely smart enough in 1972 to buy See's. Barely smart enough because he says that if the family didn't budge to our stupid demand of $25 million, we would have walked.

If you go backward and think about it, they could have paid $100 million for that business, and it would have been a low price based on what happened after that. Right? So it was a phenomenal business. The only thing Warren did, the only input he provided to management, they kept the same management. Chuck Huggins kept running the company.

The only thing he did was say, "On January 1st of every year, I will send you the new price list." So he took over pricing for the company. All the peanut butter brittle and their fudge pricing and everything else, beginning of the year, Warren would look at, "Okay, you know, inflation is 3%. Let's bump all the prices by 12%." Year after year they found they could raise prices significantly above the rate of inflation, and it didn't have any negative impact on sales. Sales just kept going.

But they also found out a few other things. They got a huge education in brands and branding, and that education in brands and branding was very fundamental to the Coke purchase. So See's is a California phenomenon. You know, people in California, if I had the same talk going on at Columbia University or something and asked the same question, they’d look at me like I was on Mars, probably never heard of See's, except for a few that have gone to Omaha.

They repeatedly tried, and Warren and Charlie occasionally would try to nudge management to expand See's into other geographies. Every time they tried to expand into other geographies, they would fall flat on their face. So, they'd open a store. I think one time they had a store in Chicago; never worked.

They've opened stores in several geographies; it's never worked. But slow expansion in California has worked. They found that the brand had certain brand value in California. They also found that people were willing to pay a premium for See's candies in California, but that same cachet didn't follow through in other locations.

So when the Coke idea came in front of them, there were a couple of things that were different about Coke from See's. The first thing was that Coke traveled really well. They could see that repeatedly. They tried to take this brand into even the neighboring states; they couldn't do that. There are only two countries today in the world where you cannot get Coke.

I forget; there was North Korea is one of them. I forget what the second is. Pardon? Yeah, Cuba; that's right. So, Cuba and North Korea are the only two countries where you cannot get Coke today. Right? But what they noticed is that even in these two countries, if Coke tomorrow started selling in these countries with no advertising, it would take off in quite a significant way because that brand has meaning, even to people who have never drunk Coke before and never seen an ad because it's so much part of pop culture and movies and whatnot that it's entrenched.

Basically, what they found is that, unlike See's, Coke traveled really well. Warren studied this phenomenon of the difficulty of traveling with See’s very carefully because he was very interested in making See's global. He would have loved for See's to become a global company, and with all the brainpower they had, they could never do that.

But here was a company that was naturally a global company. The second thing he noticed was that there was a limit to the amount of fudge you could eat. You know, so as you eat more fudge or See's candy, your ability to eat more of it declines.

But with Coke, the lack of an aftertaste means that the ability to consume Coke was quite significantly higher than the ability to consume candy. In fact, a person could consume five or six Cokes a day, pretty much for their whole lives, without really feeling like they were having something monotonous.

How many of you have one or more Coke products daily? No one admits to having Cokes. Actually, you're having other Coke products; you just don't recognize that they're made by the company. They've got over 100 brands.

So, the second thing they recognized, unlike fudge and peanut butter brittle and such that you couldn't, Coke, you had no aftertaste. The volume you could consume and the frequency with which you consume it was quite different. In fact, even if you compare it to something like McDonald's, which is a very good model, if you were eating at McDonald's every day, that could probably get to you much faster than consuming Cokes every day.

They noticed that this particular product has this nuance of recurring consumption not really being an issue in terms of purchase. So these were some of the models that they knew about before they started to research Coke.

The third thing they also recognized as a difference between See's and Coke was with See's you needed retail space. Right? So they had to have a See's store and, you know, pay rent and all these things to sell it. But Coke sold in all these places where the company didn't pay any rent. You know, it was just sold all over the place.

It had, and I'll go through a little more detail about the kind of capital-light model of Coke. So, there were a number of reasons why Coke was very capital efficient, far more capital efficient than even See's was. Even though See's in '84 was producing $13 million on $20 million invested capital, I mean, that's a very high return. You know, a 65% return on invested capital; really good business—Coke was even better than that.

It was a truly remarkable business. The second part of the mental models that come in is that Warren and Charlie like to go through long histories of these companies that they study. So with Coke, both of them read every annual report since the company was public.

They read every annual report from 1919, which is when Coke went public, until the late '80s—every single annual report. They got some insights from reading those annual reports. One of the insights they got was that from the period of 1919 to let's say '87, there had never been a year when Coke's unit or cases sold were lower than the previous year.

So through the Great Depression, through the Second World War, through the Korean War, through all the stagflation of the '70s, unit case volume just every single year went up over the previous year non-stop. The second thing that they noticed was that Coke, which started in Rome, Georgia, went through this major International expansion.

They were repeatedly over the years, first only in the Southern US, then they spread throughout the US, then Canada, and then they started spreading out. In fact, World War II took them to all the places where the US Army went. They saw the whole way Coke entered one new country after another and what happened after they entered the country.

They could see that from the reading of those reports. What they concluded was that the runway was really long. I'll get to the runway. So the way they defined the runway from reading Coke is that humans need to ingest water to survive, right? So we need to ingest about 64 ounces of water a day to survive, and humans prefer to consume flavored water over plain water.

So at least some portion of that 64 ounces, they prefer to consume flavored versus plain. In fact, Warren's daughter says that she's never ever seen her dad drink water. She says she's never seen her dad drink a bottle of water or drink a glass of water. Never happened.

So Warren, I think, what, 40 ounces a day is coming from Coke? I don't know where the other 24 ounces are coming from, but she says water is not part of the deal. If you take the 64 ounces that humans have to drink, they figured that at infinity, you'd probably get to something like 50% of that volume gets consumed in one way or another in a flavored format.

And you can take that today where if you look at something like Dasani, which is a Coke brand for water as part of that. Some kind of bottled kind of beverage becomes about half of it. They felt that Coke could probably take 50% of the flavored portion, so 16 ounces per day per person, which is two servings.

They looked at the unit volume, they looked at the number of servings, they looked at the number of humans, and they looked at that runway, and they said that we've got a long ways to go here. So you've got basically this distribution engine where you can pump a lot of brands through it. You know, Minute Maid, and you know, Monster, and all these things.

World population was growing. So as world population grew, Coke consumption would grow. GDP was growing in countries where GDP is very low. If you look at a country like Mexico, for example, the per capita Coke consumption in Mexico is the highest in the world. It's above the US, and there are other countries in the world where they are at 1/100th of Mexico's volume.

Coke would grow as it went into new countries. It would grow as GDP grew. It would grow as per capita consumption grew. That was another part of what they learned from reading those annual reports.

Then Warren read this Fortune article which was written in 1938 about Coke. The writer of the Fortune article said that, you know, this is a marvelous company in 1938 that has done so well. Then he said, "Well, of course, the ride's over," because the company went public in 1919 at $40 a share, and now that is worth $3,300 per share if you go back to the stock splits and all that.

They said, "It's great to know that, but you know, the ride's over." Warren says the ride was not over because if in 1938 you invested a fresh $40 into Coke, by 1993 it was $25,000.

You could have missed the first 20 years and still had runway after that. Another model they used was they didn't have an anchoring bias. A lot of times in investing, what happens—and, in fact, I'm very guilty of that—is we tend to look at past performance of a security, and that taints the way we look at it.

Actually, what you really ought to do is ignore the past and just focus on the future. So they were really good at not having this bias about, "Hey, this company's been growing from 1884 till 100 plus years now. We want to invest in it, and 100 years after this company got formed, we're putting 1/4 of our capital in. Have we lost it?" They didn't think about it that way.

Some of the other things they realized were that the company was currency-proof, it was asteroid-proof, it was thermonuclear blast-proof, it was anarchy-proof. It was pretty much bulletproof. If you think about a situation where you have, let's say, an extinction-level event take place, right? So let's say an asteroid comes in and takes out 6.5 out of 7 billion humans.

Let's say we are left with a few hundred million. The Coca-Cola company has the trademark, and they have the formula, and they will eventually start producing Coke again. They'll probably get back into business and such, and you would not say that about almost any other business when you have that sort of event take place.

So even if currencies changed or got devalued or whatever happened, Warren's perspective was that people would be willing to trade 2 minutes of labor for a Coke. The trading of labor versus Coke would be independent of currency. That was another part of the model.

Then, you know, the notion that our mouths are a very personal space, right? There are a few spaces humans have that are very sensitive, and our mouth is one of them. We're kind of sensitive about what we put into our mouths. So if you see a Coke and you've had it in the past, etc., you won't think twice. Even if you're in a different country, you'll have it, no problem.

But if you see some kind of unknown brand, it's kind of like, you know, you eat Wrigley's chewing gum, and then someone presents to you Glot chewing gum and says, "Would you like some?" You know, you're probably not going to take it.

So our mouth is a very personal space, and we're not going to be messing around with trying to take the low bid on what goes into our mouth. They felt that we are creatures of habit. Once we get these habits formed, then we're not going to be willing to change them, especially with personal spaces like our mouth.

The second is about humans being creatures of habit. You know, we shave every day on the same side of the face first, or in the case of ladies, the same leg first. We do things in a certain pattern. Once we get to those habits and patterns, we are reluctant to make those changes.

They saw all these things, and they saw all of this was kind of coming together from reading the annual reports. I've probably gone through maybe 20 or 30 different models they used. We still have a lot more to go.

There's a lot more models they went through, but in all the models that I've gone through with you, we haven't talked about any numbers, you see? So I went through all this stuff about it being a great investment, but we haven't talked about numbers really.

Now I'll just go through some numbers, but none of these numbers need a spreadsheet. They're kind of very simplistic numbers. So the way the coke model works is the Coca-Cola Company produces concentrate and syrup.

Let's go back to the point where there's just one product, which is Coca-Cola. We won't go through the 100 brands they have right now, but let's say there's only one product: Coca-Cola. They produce concentrate and syrup. The syrup gets sold to bottlers around the world, and the bottlers then produce the Coke cans and bottles that you see in supermarkets and everywhere else.

The Coca-Cola Company also sells the syrup to various fountain operators. So, like Burger King and McDonald's, and so on, where you can buy fountain drinks. So there are two models, right? So there's the bottling model, and then there's the fountain model or let's say restaurant and such.

The way the bottling model works is the Coca-Cola Company does not set the price of a bottle of Coke. It lets the bottler do that, so they can set whatever price they want. What it does do is it sets the price for the syrup, and what it does do, just like Warren did on January 1st with See's candy, is on January 1st, they bump the price of the syrup non-stop.

They've been doing it for 100 years. The simple economics are that if you have a can of Coke on sale at Costco, or wherever you might get it for about 25 cents, the Coca-Cola Company gets around 6 cents or 7 cents of that comes to the Coca-Cola company for the syrup. The rest, let's say 18 cents or so, is shared between the retail outlet that sells it and the bottling operation that produces it.

The bottlers are where a large amount of the capex is happening, right? Because they've got all these bottling plants, they've got all these trucks, they've got drivers, they've got all the distribution going on. The Coca-Cola Company just needs a few plants around the world to produce syrup.

When Warren and Charlie were going to make the investment, the Coca-Cola company had 177,000 employees; all the bottlers had a million. The capex is on the bottlers. This is See's candy on steroids because you don't have any retail.

It reminded me of one time I was visiting Microsoft. I think this was like probably 15 years ago. They used to sell their operating system to, for example, Dell. So, Dell would install Windows on all the machines. I was talking to one of the Microsoft engineers. I said, "So do you guys sell, send the CDs to Dell, and then they send you the computer, and you get the CDs and such?"

They said, "No," or the floppy discs. They said, "No." He said, "We give them one copy, and then everything else is their cost." Okay?

So Microsoft wasn't even willing to spend the money on the disc. Even that they dumped on the PC makers. That was even better than the syrup business. At least, they had to provide syrup. In the case of Microsoft, they just provided a bit once, and then they charged you on the bits, which is why it's such a beautiful model and why Mr. Gates is the wealthiest person on the planet.

So, it's very funny; like, he said he looked at me like I was dumb as a doorknob. He's like, "What do you mean? I'm going to send them CDs? No, I'm not going to send them CDs. I'm going to give them one copy."

Then they told me that once you got to streaming, we didn't even send them a copy; we just streamed it to them. You know, we’re not going to send them a single copy.

So, in the case of Coke, it's not quite Microsoft. They still had to sell the syrup. But what they did is they came up with one more enhancement where they got to concentrate. So the syrup had sugar in it, so what they did is it had water and what's the point of shipping these heavy things? They actually improved the model to just giving concentrate and telling the bottler, "Add so much sugar and add so much water, and now you've got the concentrate."

They even took it down one level further. So you take the 25-cent can; the Coca-Cola company gets about 7 cents. The cost on that is basically next to nothing. It's sugared water; they're not even paying for the sugar. Bulk of their, you know, they spend about 10% of that on advertising, and approximately about 25% or 30% of that number is pre-tax profits.

So that's basically their model on the bottling side. Now, when you get to the fountain side, things get even more exciting. So when you go to a restaurant and you ask for a Coke, they don’t charge you 25 cents. What do they charge you?

A couple of bucks? Yeah, so, you know, that 8 or 12-ounce serving is now $12. The Coca-Cola company is giving it to the restaurant at probably, I don't know, 15 cents or something, and they are very benevolent, and they let the restaurants make a lot of money on the Cokes.

What happens in that format is the restaurant loves Coke. You know, it's the highest-volume, highest-margin product of anything they're going to sell, right? And people want it, and people ask for it by brand name, etc. Like, you know, the ones that don't offer Coke, they have to ask you, "Would you like a Pepsi instead?"

You cannot say, "Oh, okay, it's fine. I'll take the Pepsi. Take a bullet for the team." So, the fountain sales model, if you think of the ecosystem, everyone makes money. You know, the restaurant makes a lot of money; the restaurant's very happy. The bottler that converts the concentrate to the syrup makes money; they're very happy because they deliver it. They do the last-mile stuff, and the Coca-Cola company is obviously very happy.

Both these models work really well. Just to give you kind of a sense of the capex differential, you know, before they made the investment – these numbers have gone up quite a bit since then, but they scale. All the bottlers were spending in the mid-'80s about $1.3 billion in capex every year, and the Coca-Cola company was spending $160 million.

Approximately like 12% of what the bottlers were spending. Most of the volume, or most of the benefit of all of this went to the Coca-Cola company. Then, Warren has obsessed over the fact that there were, you know, Branson had started Virgin Cola. Then there was Sam's Choice, and there were all these kind of private label-type colas, and they studied that.

Bottom line is that none of those ever got any traction. So why didn't they get traction? Well, number one, you know, the personal space, the mouth. You know, you're not quite sure about Sam's Choice, even though you like Sam Walton. The second is the economics; they can't really undercut.

If you think about the 25-cent can, well, the reason it's at 25 cents is because of global scale. This is a global company selling at a huge volume. I mean, they're buying aluminum at a huge volume and all those things. Right?

So, you try being even Walmart with whatever volumes Walmart has, and then you try to get customers to not buy Coke and buy Sam's Choice. How much can you undercut Coke by? They've got about two cents that they're making on that 25 cents as profit, and the bottler is probably making another couple of cents.

So you got about four cents. Once you go to, if you had the exact same cost as the Coca-Cola Company, if you were at 21 cents and Coke was charging 25 cents, you would make no money. If you didn't discount versus Coke, who would buy Sam's Choice? How many of you consume Sam's Choice? Does it even exist anymore?

I haven't been to Walmart lately; does Sam's Choice exist anymore? Alex, you haven't kept up! No? All right! So, but in Costco, I don't remember; maybe you guys know, because I don't think Costco has a generic cola. Do they sell? No? I don't think so, right? Do they have Refresh?

Is that the store brand? That's like. Yeah, so they've got some private label, but they've got the big containers. Okay, who drinks Refresh? Is it cheaper? And do they have a cola?

I think they're water. Okay, all right. So you see that? What they found is that if a competitor tried to come in, and, the store tried to do a private label or whatever else, they really couldn't undercut them because the economics just wouldn't allow it.

This is what they understood about Coke, some of the things they understood about Coke when they read those annual reports. Now, we get to another set of mental models, which is the mental models on branding.

So, the Coca-Cola Company basically, you know, now the market cap of Coke is about $190 billion. I'm guessing they're, you know, probably 17 times or something. I think they're probably making like, I don't know, $12 billion or $13 billion in after-tax profits.

The Coca-Cola Company has always spent less than 10% of their revenue on branding. One of the things about the branding is, so when you see a can of Coke, the can of Coke is actually branding, right? Because it's all got the brand and everything. Who's paid for that?

It's the bottler. Is that part of the 10% that the Coca-Cola Company spends? No. That Coke can is completely paid for by the bottler. Those red trucks you see are paid by the bottler; that's also not part of Coke branding. So every single case and can and stuff about the fountain displays and all that is all kind of continuous branding going on without them spending a dime.

Others are spending the money on that. When Warren invested in the Coca-Cola Company, they were spending less than a billion a year on branding at the time.

He said that if you gave me $100 billion and told me to take away the market leadership of Coke, I would just return the $100 billion to you; it couldn't be done. Even though they had spent so, it had been 100 years, it had grown. They were spending less than a billion, you know, a decade or two before that.

The unusual thing about branding is that when things get etched in our brains like Coca-Cola is etched in our brains, it has a multi-year effect. What Coca-Cola spends in 2016 on branding is not exhausted in 2016; it has a residual effect even 50 years from now.

When you have a business that's been at it for over 100 years or more, that brand just keeps getting more and more popular. One of the things, another of the mental models is that red and yellow are primary colors for humans. You know, we get attracted to red and yellow more than anything else.

So, when I look at logos and they use primary colors like that—like McDonald's makes great use of red and yellow; Wells Fargo does great use—especially logos that have those primary colors, I think they have more of an impact long-term than the non-primary colors.

Basically, one of the things about Coke is that this brand has got itself so deeply etched into our psyche after all these decades and more than a century that the cumulative effect of everything they've done in the last 100 years exceeds what they spent in the last 100 years in terms of brand value.

It significantly exceeds that. Warren felt that for $100 billion, you couldn't take away the leadership of Coke. At the time they were investing in Coke, the market cap was less than $20 billion.

They had a huge amount that they could get. The other thing about Coke is that we'll finally turn on PowerPoint; sorry to talk so long. The other thing about Coke is that these are some scenes from different restaurants in rural India—in the middle of nowhere, actually. They're not in any cities or anything.

If you see that top restaurant called Prakash Dhaba, that's in the middle of nowhere in India, and you see all that Coke signage everywhere. Here's how that happens: the bottler, the Coke bottler, goes and meets the restaurant owner and says, "Listen, do you want a paint job? Do you need furniture?" and all for free.

He says, "Oh yeah, of course, you know, furniture is great." So the furniture is going to be red; you see all the red furniture. The one table was probably what they had before they got left.

Then, the second day, he says, "Do you want us to put your business name on the top?" He said, "Yeah, sure." So what they do is you see on the left that Prakash Dhaba name is a little bit there, and the rest is all Coke.

Here’s the funny thing: the restaurant owner loves that. And why does he love that? He loves that because people trust him. You know, he's got a trusted brand. So now they think, "Oh, you know, this place can't be so bad. We can get our Cokes and we can get all the other food and all that."

It's the, what Munger would call the association tendency. So what happens here is the Coca-Cola Company gives some matching funds to the bottler, and they tell the bottler, "Listen, go paint the town red." Okay? Literally paint the town red.

We'll give you a little bit of change, and you see that the second picture on the left is the inside—not the same restaurant, a different restaurant.

I think that guy is only an outdoor place. So here, same thing: we'll give you a paint job, and all the furniture is red, and everything's red. The guy is probably very happy about it and such.

Basically, the thing is that these types of signs and these types of insignia, you would see deep in rural China. You know, very deep in rural China, you'd see very deep in rural India, in the middle of nowhere, you'd see this.

I mean, the penetration is way beyond the cities and all that. It has gone deep into the hinterlands. So that distribution all the way down at that level is extremely powerful.

When you look at this brand, even though the company spends less than 10%, the actual amount of impact it has is just massive. One time I interviewed a guy, and he worked for Coke in Atlanta. He lived with them all over the world. He was originally from Morocco and was part of the team that managed the World Cup relationship for Coke with FIFA. That was his whole job, and him and, you know, probably 30 other guys at Coke.

So, I'll get into this a little bit later, but the association tendency of being at places where humans are happy. You know, so the FIFA relationship with Coke and all the global sponsorships—the Olympics, you know—so all of these places; McDonald's, where people are generally happy, Coke wants to be there, right?

The etching of this brand over the decades in all these places all over the world is huge. And then we get to the managers. So, Coke had such an incredible model. This is a company that just produces fountains of cash. You know, it just gushes cash. You just can't lose money. You just, you know, just send the syrup and you're getting massive.

Generally speaking, what happens is that when you have businesses with great business models, you end up with dumb managers who do dumb things because even when they do dumb things, they look really good because the business is so good.

So Coke would put their money into buying shrimp farms in Thailand and all these unrelated businesses, and almost everything they bought was a far worse business than the core business that they had. In 1981, two guys came on the scene: Roberto Goizueta became the CEO, a Cuban guy, and then Don Keough became his, under him, the president.

These two guys, and Goizueta was, you know, there were some unusual people in the history of Coke going back the decades, but Goizueta was a very unusual guy. He was really good at marketing and branding, understood this model very well, and he was really good at finance.

He understood capital allocation very well—very unusual to have a numbers guy with a branding guy put together, and Keough was just a great operator. So what they did when they came on the scene in '81 is they started dumping all the other businesses. They got rid of everything Coke that was not related to beverages.

They got rid of, and the only thing they bought was they bought Paramount Pictures in '89, and then they realized about 5-6 years later that even that was dumb. They dumped Paramount Pictures in '87 or '88.

What Warren saw was from 1981 till his first purchase in '88, in seven years, that these two guys, finally, this was a company that had real capital allocators. What they were doing was aggressively buying back the stock.

The Coca-Cola Company started doing was they had this gush of cash coming in. The dividend was going on. It is one of the only companies that for 50 years— I think more than 50 years now—has raised the dividend every single year.

I think there's no other company on the NYSE that's done that. Some have maintained it, but they've raised dividends every single year. The first thing they did was they cut out, got rid of all the crappy businesses, sold them.

And the second is they started aggressively buying back stock. Basically, they took their cash flows, and Goizueta was brilliant. Warren, I think, saw what was going on with Roberto Goizueta and Don Keough, coupled with all the other stuff I just told you.

Now you finally had a business that had management that got it, and that's why they went in. Roberto Goizueta himself owned 2.5% of Coke, so he had a significant economic interest, and went from there.

You know, the thing is many of you are skeptical because of the whole sugar issue, right? Like if I ask you, do you drink Coke? Most people say, "No, because I don't drink sugar."

They actually addressed that this year at the annual meeting. So Warren says that he's 86 years old in great health, been consuming five Cokes a day, Cherry Cokes, since he was 6 years old. He dismisses all these health issues people bring up with sugar and whatnot, and he says that, you know, he wishes he had an identical twin brother who spent his whole life eating broccoli.

If I had this identical twin who would just drink broccoli and plain water, then we would have a test. We would see him at 86, and we’d see me at 86, and we’d see who was healthier.

Basically, his perspective was that, and I think he talked about it as a joke, but then Munger actually elaborated. He said it is very dumb to discuss negatives about a product without discussing the positives, right?

One of the things we have to realize as humans is that yes, excess sugar has problems, you know, causes health issues and whatnot. But having a Coke at certain times will add a lift to your step, right?

So that lift to your step is very difficult to quantify, and I think this is the reason why Warren says he wishes he had a twin brother. The thing is the guy lives such a happy life on all fronts that I think science doesn't fully understand the impact of low stress and happiness on health, right?

There's an impact there which we don't fully realize, but I'm pretty sure it's there. So yes, if you go wild and crazy and have huge amounts of sugar consumption and then that leads to health issues, yes, there's a problem.

But you can be Usain Bolt drinking two Cokes a day and be just fine. So, there is. They don’t see the sugar issue as being a significant issue for Coke. The second issue with Coke is they now have more than 100 brands.

A large number of their brands, including Coke, have no sugar, and a large number of them even have no carbonation. So, when you get to these places, they're not pumping Coke over there; they're pumping Danone, they're pumping Minute Maid, they're pumping all kinds of products through that distribution engine, right?

So it's not just sugar being pumped through. The other thing about the company is, just to tell you how Coke has made a lot of blunders over the years.

One of the blunders they made is that they never wanted the Coca-Cola product to have anything but the true Coke product in it. When there was a concern about sugar and people were talking about diet drinks, they did not want to create Diet Coke.

They did not want to call it Diet Coke, and they didn't want to take that beautiful bottle and the red color and mess with it. They didn't want to do that, so what they did is they called that product Tab.

How many of you have heard of Tab? Some of you? Yeah? See the older guys, older guys heard of Tab. For the longest time, Tab was this, you know, stepchild. Then Tab became Diet Coke.

Eventually, they realized that they could put the Coke bottle with the diet without the sugar, and it might still work, and it worked. They got to it.

Now we’re getting to the finally the part about what I call the Lollapalooza section. How many of you read the Lollapalooza paper? I think some of the folks have read it, right?

That was a speech which Munger gave when they told him it was useless. Munger kind of inverts logic. He says, "How do you create a $2 trillion company with a $2 million investment, right?" How do you create that?

The way he does it is he says, "Look, let’s go in 150 years." He says, "In 150 years, how do you take $2 million to $2 trillion?" The way he does it is he says 150 years to '34, which is 150 years from when Coke was formed.

He says that if there are 7 billion humans and they're consuming the 64 ounces, and then half of it is flavored, and then one half of the flavored comes to Coke.

We are getting about 2 cents of serving, let's say by then with inflation we're getting about 4 cents of serving. You run all of the numbers, and Coca-Cola at that point is making about $117 billion a year in profit, which would give you a market cap of $2 trillion.

That's how we get to $2 trillion. So, he says, "So what are the things we do to create that $2 trillion?" He says, “First of all, this guy Glot, who's setting up the Coca-Cola Company, doesn't want to call it Glot flavored sugared water. He wants to call it Coca-Cola because he likes that name better, and so he creates a name.

He does a lot of stuff to promote the name. The second is he says, in 1884, consumption of sugar and caffeine is well accepted in society. You know, we have coffee, tea, lemonade.

So, we use sugar and caffeine because people like that. Using sugar and caffeine, we're going to create this product." Not just with sugar and caffeine: what we'll do is we'll give it color, like the color of wine, to make it look kind of high-end, and we'll give it carbonation to make it like champagne, okay?

So, we'll put the sugar and caffeine and the color of wine and carbonated, and now we've got a great product. Then we sell it really cheap so that everyone can buy it.

We have a choice: do we create a beverage that's hot, you know, like coffee or tea, or a beverage that's cold? He said, "Well, cold beverages can be consumed at a much higher volume than hot beverages. When you're near the equator and really hot, you have an almost unlimited ability to consume cold beverages."

So, he says it's a no-brainer; you go with cold. Now we go into the mental models of the way human brains are screwed up.

So he says the first is the association tendency, which is that, you know, put it in places where people are happy because when people are happy and they see Coke, then they associate happiness with Coke.

We finally get to my favorite slide, which is the Maryland slide, right? The association tendency is, if Maryland's drinking it, then definitely I want to be drinking it too, right?

And so, the association tendency, what Coke did in all its ads for the longest time and even now, is they associated with celebrities, right?

So, in India, they'll pick some of the top Bollywood actresses. The same thing here; they'll put these people in because the association tendency, humans can do very well with that.

Then the social proof tendency of humans is another mental model, which is, you know, monkey see, monkey do. When we see other people drinking Coke, we want to drink Coke too.

So show people having a good time with Coke and all of that. Then he says, you know, do it both ways: do it with fountains and do it with bottles.

He says another thing we would do with the Glot Beverage Company is that we would basically create this aura around secrecy. People think there's something unusual about Coke because the formula is secret; it's in a vault in a bank.

Quite frankly, the secrecy means nothing because he says eventually, with food science going the way it was going, everyone would figure out how to make something close to Coca-Cola. But by the time they figured it out, we would have had brand and other things come in, which would help us kind of keep the competition at bay.

The food chemistry that helps our competitors make a product like ours also helps us by reducing the unit cost, like went in the US from sugar to fructose, which was a lot cheaper.

They just made their whole efficiencies in how they got there. Then he goes to jacobe inversion, which is, you know, what not to do. What are the things that you don't do to get to the $2 trillion?

He says the first thing that you don't do is avoid losing half the brand name. You know, the Coca-Cola brand name has two parts: the Coca and the cola.

He says don’t lose either part of it. If anyone came up with anything called cola, sue them and take them out. In an ideal world, he would have made sure there was no other cola.

They could call it whatever else, you know, Glot bottled water or carbonate whatever, but no cola, right? So, that’s the first thing he said. You wouldn't lose half your brand name. You would avoid any by basically having a standard, great product at a great price, which they did.

The final thing he said that, you know, don’t change the flavor, even if someone comes up with something better. Keep the flavor because it's not about the flavor; it's about the brand.

That brings us to the cola wars, which very few of you are familiar with. How many of you are familiar with the Pepsi challenge?

Yeah, this usual cast of characters, except you. How do you know about the Pepsi challenge? You read? Okay, all right, good! So, basically, Pepsi had a problem in the mid-'80s.

They had a problem; they knew that people preferred Coke by a huge margin to Pepsi by like a two-to-one margin. They knew that their brand was inferior. You know, if Burger King offered Pepsi and not Coke, then people would not think of Burger King as well.

So everywhere they had to discount stuff, and all these things; it was really hard for them. John Sculley, before he went to Apple, he became the one who went to Apple and then Ed, Steve Jobs.

So before he went to Apple, John Sculley was the chief marketing officer of Pepsi. He was brilliant. He said, "How do I take out Coke?" He said, "The way I take out Coke is I take away the brand name.

The way I take away the brand name is I ask consumers to do a blind taste test." In a blind taste test where you, so you know, if you put in front of someone a Coke and a Pepsi, they'd go for the Coke because of all that conditioning for the decades.

But now, if you take over the brand and you just give those tasting cups and then have them taste it, well, Pepsi is sweeter; it actually tastes better, right?

So in the blind taste test, people will say, "Oh, I prefer this one." Then they show you that it was Pepsi, right? So they started taking market share, and Coke got rattled.

Guizueta and Keough, who were part of Coke at that time, freaked out. They said, "You know, basically, these guys have figured out that our product is inferior." What they did is they came out with New Coke, and New Coke was sweeter, and it was better than Pepsi.

There was a major uproar, right? All the die-hard Coke guys were horrified that how can you change the formula? I mean it's all about the formula. I want Coke; I want New Coke, right? There was this huge fiasco.

Now they had messed with the family crown jewels, right? They took away the one thing that was there, which was that secret formula. All the things about the secret formula—In reality, Coke had changed the formula many times, but they never told the public that they changed the formula.

Right? They just did it quietly. This was very visible. They called it New Coke, and there was huge backlash. Then they introduced classic Coke.

So then there was New Coke and classic Coke. You remember that? We had both, right? That was even more confusing. Okay?

Then they finally realized we got to kill this whole thing. Go back to just Coke, and that's what they did. They went back to only Coke, and they survived that.

So what Munger says is that look this essay I wrote about taking $2 million to $2 trillion, he says in reality the company started in 1884, and by 1896, 12 years after they started, they had no earnings, and they had 150,000 in total assets, so much less than $2 million they started with.

He says they lost half their brand name, right? So, they were not able to protect the cola part of the brand name; they lost that, and they also screwed up with the envy of Pepsi, and they went to New Coke, all of that, right?

They did all these mistakes. Also, I think in 1900, they didn’t think bottling was going to be that big. They thought bottling was kind of a sideshow, so they signed these agreements with these bottlers, which fixed the price of syrup permanently into the future.

In 1900, they said we will give you syrup at whatever cents per pound for the next 100 years—fixed price. Okay? That completely destroys the market because then sugar went sky-high, and they started losing money.

So then they’re telling the bottlers we can’t give it to you; they said, "No, you have a contract!" They had to battle the bottlers, and finally, they got some leeway from that.

The bottling rights; what they had done originally when they gave bottling rights was it was a day's horse ride. The way they set it up was that they looked at how far a horse could go in a day and a back, and that's how they defined the territory of a bottler.

That didn't make sense once you got to automobiles. They had very big territories because Coke started expanding, and so they wanted to reduce those territories. The bottlers didn't want to give that up, and the second is that they had so many useless bottlers. Right?

So, these bottlers—this is the license to print money. You've got a monopoly in your area; you got the Coke product; it's going to sell, and you don't need to be that great of a businessman.

So, they had to really kind of go through Don Keough and do a lot of work where they brought back a lot of bottlers and did all kinds of things to get their model back. In spite of all that, Coke from 1884 till now, with all the dividends they’ve given out, they're now at a—when Munger gave the speech, the market cap of $125 million in '96, he said if Coke's market value grows by about 7.5% a year, you’ll get to $2 trillion from '96 to '34.

If you go to today, of course '96, I think was an inflated multiple. If you go to today, Coke is at $190 billion. To get to $2 trillion by 2034, you would need to be at about 14.5% a year.

I'm not sure they'll do that, but the other thing that could happen by that time is since we get these cycles in the stock market, you might have a 30 multiple on the company. You know, Coke was sitting at a 40 multiple in 1999.

There’s a chance you might get some crazy multiple by that time, and that might get you to $2 trillion. Basically, what I wanted to just say is that you can see the work that Warren and Charlie did.

Usually, the thing is, one is they get a little bit of information edge because they're willing to dig deep. You know, they’re willing to read a lot and whatnot, which most people aren't willing to do.

The second is where they get a lot of advantage is the synthesis. You know, when they read, what are they kind of extracting out of that model? The third is that they understand that when you have multiple models interplaying with each other,

I mean, when you put a great manager like Goizueta on top of a great business, you just get phenomenal returns. They are just exceptional in terms of what ends up happening—a great business with great management.

You get some of these other nuances about personal space and all these other things about brand and such, and you get to these "lollapalooza" effects. In the investment business, I think this is the Holy Grail.

You know, this is kind of when you get to this level of analysis on a business, you got it. And then the key is to make very few bets, make very infrequent bets, and when seven moons line up, you bet big.