April 19, 2009 in Business

Coke’s loss in China may turn out to be good for shareholders

 

Citing Coca-Cola’s “market dominance in carbonated soft drinks” in China, the nation’s Ministry of Commerce recently rejected Coke’s bid to acquire China Huiyuan Juice Group (CHJ), fearing that the acquisition would limit competition in China’s juice market.

This may not be such bad news for Coca-Cola shareholders. China is already Coke’s fastest-growing market, with quarterly unit volume up 29 percent year over year. And Coke’s $2.4 billion bid was rather pricey, at 45 times CHJ’s estimated profits for this year, when long-term growth expectations for CHJ are 30 percent.

Pundits have noted that Coke offered a 200 percent premium to CHJ’s pre-bid market price, suggesting just how crazy a price Coke was willing to pay. Strong growth is available elsewhere. In Russia, for example, its biggest independent and publicly traded player, Wimm-Bill-Dann, was recently priced around 0.4 times sales versus the 6.5-times-sales price Coke was offering for CHJ.

Coca-Cola’s desire to get an edge on PepsiCo in China, snagging 43 percent share of the juice market by buying CHJ, is understandable. But valuation matters. It always matters.

And that, fools, is why Coke’s “bad” news is actually good news for shareholders – and why investors were wrong to sell shares of the stock based on the news.

Ask the Fool

Q: I saw that some insiders at Activision Blizzard have recently sold about 3 million shares of its stock. When insiders sell thousands or millions of shares, who are the buyers? – P.D., Biloxi, Miss.

A: Shares sold by insiders such as officers, directors or owners of a company are sold in the market, where for every seller there’s usually a buyer. The catch is that if there are many more shares for sale than there are interested buyers, the price will drop – until it reaches a point at which buyers will buy.

Those 3 million shares might seem like an awful lot to us, but remember that in the course of a typical trading day, many companies experience a high volume of trading. In recent months, about 16 million shares of Activision Blizzard have been bought and sold each day. By contrast, General Electric’s average volume tops 175 million shares, and the Washington Post Co.’s is just 40,000 or so.

It can be smart to examine insider purchases and sales for companies that interest you. Some occasional selling is routine, but someone unloading a large portion of his shares can be a red flag. When insiders buy, though, it’s hard to take that as anything but a bullish sign.

Q: Can you recommend any books on value investing? – L.W., Flint, Mich.

A: Try “Value Investing: From Graham to Buffett and Beyond” by Bruce Greenwald et al. (Wiley, $20) or “The Intelligent Investor” by Benjamin Graham (Collins, $22). “One Up On Wall Street” by Peter Lynch and John Rothchild (Simon & Schuster, $15), meanwhile, offers a good introduction to investing, as do many Motley Fool books.

My dumbest investment

My buying 2,000 shares of a company for 65 cents per share in 1996 based on a cocktail party tip was very dumb. Two years later, the company executed a one-for-six reverse stock split, leaving me with 333 shares. The stock price was soon 25 cents per share, and it kept dropping. In 2006, it filed for bankruptcy protection. No more “hot tips” for me! – M.S.Z., Sun City West, Ariz.

The Fool responds: Technically, a reverse split doesn’t affect the value of your holdings. One hundred shares of a $10 stock are worth $1,000, as are 50 shares of a $20 stock, after a one-for-two split. However, companies don’t usually do reverse splits unless they’re facing some challenges, so we should see them as red flags. (A reverse split can make a stock price look less embarrassing, among other things.) Companies that have recently executed or announced plans for reverse splits include Citigroup, Borders, Rite Aid and Time Warner. Your main error, as you know now, is buying on the basis of a hot tip – always do your own research and thinking before buying anything.

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