Investing Guidelines: Value Tenets 127growth, the present value of the company discounted at 9 percent
would be $38.163 billion. At 10 percent growth for ten years and 5
percent thereafter, the value of Coca-Cola would be $32.497 billion.
And if we assume only 5 percent throughout, the company would still
be worth at least $20.7 billion [$828 million divided by (9−5 percent)].
Gillette
Berkshire, as mentioned in Chapter 4, bought $600 million worth of
convertible preferred stock in July 1989. After a 2-for-1 stock split in
February 1991, Berkshire converted its preferred stock and received 12
million common shares, 11 percent of Gillette’s shares outstanding.
Now that Berkshire owned Gillette common yielding 1.7 percent
versus the convertible preferred yielding 8.75 percent, its investment in
Gillette was no longer a f ixed-income security with appreciation po-
tential but a straight equity commitment. If Berkshire were to retain its
common stock, Buffett needed to be convinced that Gillette was a good
investment.
We already know that Buffett understood the company and that the
company’s long-term prospects were favorable. Gillette’s f inancial char-
acteristics, including return on equity and pretax margins, were improv-
ing. The ability to increase prices thereby boosting return on equity to
above-average rates signaled the company’s growing economic good-
will. CEO Mockler was purposefully reducing Gillette’s long-term debt
and working hard to increase shareholder value.
In short, the company met all the prerequisites for purchase. What
remained for Buffett was to determine the company’s value, to assure
that Gillette was not overpriced.
Gillette’s owner earnings at year-end 1990 were $275 million and
had grown at a 16 percent annual rate since 1987. Although this is too
short a period to fully judge a company’s growth, we can begin to
make certain assumptions. In 1991, Buffett compared Gillette to Coca-
Cola. “Coca-Cola and Gillette are two of the best companies in the
world,” he wrote, “and we expect their earnings to grow at hefty rates
in the years ahead.”^6
In early 1991, the thirty-year U.S. government bond was trading at
an 8.62 percent yield. To be conservative, we can use a 9 percent dis-
count rate to value Gillette. But like Coca-Cola, Gillette’s potential