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By the year 2000, Warren will have also developed an after-tax pool of dividend payouts equal to $686 million (dividend pool of $7.04 113.38 million shares income tax
on dividends of approximately 14% = $686 million).
So Warren can also project that by year 2000 his investment in Coca-Cola will have paid back his original investment of $592,401,000, and he will still get to keep the 113.38
million shares of Coca-Cola stock as profit. If the company is trading at a historically conservative rate of fifteen times our projected earnings of $3.02 a share, the 113.38
million shares of the Coca-Cola stock should be worth $45.30 a share (15 $3.02 = $45.30), or $5.136 billion ($45.30 113.38 million shares = $5.136 billion). Not bad for a
day's work.
Please note: When you are choosing a price-to-earnings ratio P/E to multiply your projected future per share earnings by, you get the best perspective by running your
calculations with the average annual P/E ratio for the last ten years. You should also run your equations with the high and the low P/E ratio for the last ten years, just to give
you a better perspective of how well you might or might not do. But be warned, stocks don't always trade at their historically high P/E. To be overly optimistic in using a
historically high P/E ratio can create projections that lead to disaster. Stick with the average annual P/E ratio for the last ten years, especially if there has been a huge
spread between the high and the low P/E ratio within the last ten years. When in doubt, choose the middle road.
Now, if we are projecting per share earnings for Coca-Cola in the year 2000 to be $3.02, we can estimate that the market price for the stock will range between fifteen and
twenty-five times per share earnings. (This equates to a P/E ratio of between 15 and 25.) This means that in the year 2000 the stock is projected to be trading in a price range
of between $45.30 (15 $3.02 = $45.30) and $75.50 (25 $3.02 = $75.50) a share. We also know that Warren's initial investment was $5.22 a share.
To determine the annual compounding rate return for the period of 1988 to 2000, all we have to do is take out the calculator and punch in 12 for the number of years (N),
$5.22 for the present value (PV), and either $45.30 or $75.50 for the future value (FV). Then hit the CPT key and the interest key (i%). This will give you the annual
compounding rate of return, which in this case will be either 19.7% for a per share market price of $45.30 or 24.9% for a per share market price of $75.50. Thus, Warren
could project an annual compounding rate of return of between 19.7 and 24.9% for the twelve-year period between 1988 and the year 2000.
We can adjust these numbers to reflect the dividends Coca-Cola paid out and any taxes Warren would have to pay if he sold the stock in the year 2000. To do this you take the
$45.30 and subtract the amount Warren has invested in the stock, $5.22 (the $5.22 is not taxed). This will give you $40.08, the amount of Warren's profit. You then subtract
35% for corporate taxes on the gain, which leaves you with $26.05. Then add in the after-tax pool of Coca-Cola dividends that Warren has been collecting for the twelve
years, $6.05 ($7.04 14% = $6.05). This gives you an after-tax profit of $32.10 ($6.05 + $26.05 = $32.10). You then add back in the $5.22, which gives you an after-tax total
proceeds from the sale of $37.32 ($32.10 + $5.22 = $37.32).
With a cost basis of $5.22 a share and total after-tax sale proceeds of $37.32, total after-tax profit from the sale will be $32.10. This equates to an after-tax annual
compounding rate of return of 17.8%. Thus, in the year 2000, if Coca-Cola is trading at fifteen times earnings and Warren elects to sell his stock, his annual compounding rate
of return after taxes will be 17.8% for the twelve years from 1988 to 2000.
You can run the same sequence of calculations for a P/E of 25, which equates to a market price of $75.50 a share in the year 2000. After you take out taxes and add in the
after-tax dividend pool, you end up with a total return of $51.73, which equates to an annual compounding rate of return of 22% for the twelve-year period. (Note: Even if
Coca-Cola's stock is trading at only nine times earnings in the year 2000, Warren can still project an after-tax annual compounding rate of return of 14.4%.)
Now, imagine if I came to you and said that I wanted to sell to you, at par value, a noncallable twelve-year Coca-Cola bond that paid a tax-free, fixed annual rate of return of
14.4% or, even better yet, 17.8%. Or how about 22%? Mouth starting to water yet? What would you do? I'd mortgage the farm, house, and kids, and buy all I could. But I can
tell you that the likelihood of that ever happening is nil.
However, back in 1988, you could have bought the stock in the Coca-Cola company and essentially got a tax-free equivalent annual compounding rate of return of between

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