Warren Buffett’s Letter – 1989 (Part 2)
Oct 8th, 2006 by Martin Lee
Marketable Securities
Buffett had his first Coca-Cola in either 1935 or 1936. In 1936, he started buying Cokes at the rate of six for 25 cents from Buffett & Son, the family grocery store, to sell around the neighborhood for 5 cents each.
While selling the product, he observed the extraordinary consumer attractiveness and commercial possibilities of Coca-Cola.
For the next 52 years, he did not buy a single share of the company, doing so only in the summer of 1988. In the past year, Berkshire’s holdings of Coca-Cola increased from 14,172,500 shares at the end of 1988 to 23,350,000.
Yet another example of the incredible speed with which Buffett responds to investment opportunities. :)
Zero-Coupon Securities
Most bonds require regular payments of interest, usually semi-annually. A zero-coupon bond, conversely, requires no current interest payments. Instead, the investor receives his yield by purchasing the security at a significant discount from the final maturity value.
The effective interest rate is then determined by the original issue price, the maturity value, and the amount of time between issuance and maturity.
For example, Berkshire issued some zero-coupon bonds at 44.314% of maturity value (due in 15 years). For investors purchasing the bonds, that is the mathematical equivalent of a 5.5% current payment compounded semi-annually.
The point about zero-coupon bonds is that the issuers do not need to pay any interest on their loans. This offers one advantage: It is impossible to default on a promise to pay nothing – until maturity date.
That also means that the time elapsing between folly and failure can be stretched out.
The warning sign for mischief-making should go to the zero-coupon issuer unable to make its interest payments on a current basis.
Whenever someone creates a capital structure that does not allow all interest, both payable and accrued, to be comfortably met out of current cash flow net of ample capital expenditure, be extra careful!
Tags: