Monday, February 24, 2014

Valuation of PepsiCo Inc. - The Long Case Looks Strong

Last week management of PepsiCo. Inc. (PEP) announced earnings for 4Q and full year 2013.  The results were fairly mixed with revenue increasing around 1% over 2012.  North American soda consumption continues to be a drag on the growth of the company as international beverage and snacks show solid growth.  The Board of Directors also announced a huge 15.4% increase in the quarterly dividend from $0.5675 to $0.655, although the new dividend rate doesn't start until the June payment.  PepsiCo Inc. was trading around $78.00 on Thursday, February 20th giving a forward yield of 3.36% based on the new dividend rate.

DCF Valuation:

Analysts followed by Yahoo!Finance expect PepsiCo to grow earnings 7.86% per year over the next five years and I've assumed they can grow at 6.29% (80% of 7.86%) for the next 3 years and at 4.50% per year thereafter.  Running these numbers through a three stage DCF analysis with a 9% discount rate yields a fair value price of $111.09.  This means the shares are trading at a 29.8% discount to the discounted cash flow analysis.

Graham Number:

The Graham Number valuation method was conceived of by Benjamin Graham, the father of value investing, and calculates the maximum price one should pay for a company given the earnings and book value.  PepsiCo Inc. earned $4.32 per share in fiscal year 2013 and ended with a book value per share of $15.96.  The Graham Number is calculated to be $39.39, suggesting that it is overvalued by 98.0%.

Click here to read the rest of the analysis.

10 comments:

  1. PIP,

    Thanks for the article on Pepsi. I think buying in the 70's is with a 3.3% yield is pretty solid. I initiated a position last week through Sharebuilder. I will probably be adding more in the coming weeks. Coke is also looking good. I'm glad both companies were able to give nice dividend raises.

    ReplyDelete
    Replies
    1. MDP,

      The 3.3% yield should be a great starting point for a long-term position. Both increases were very much appreciated over here.

      Thanks for stopping by!

      Delete
  2. Hi PIP,

    the graham number is always to high!
    I think you can use this number only in crashes.

    And PEP is a great company.
    A dividend increase about 15% is awesome!

    At the moment I have no shares from PEP or KO in my portfolio.
    But I´ll buy this companies in the next 6-12 month!

    Best regards
    D-S

    ReplyDelete
    Replies
    1. D-S,

      The Graham Number usually does show that the shares are overvalued, but I think part of that is that the times have changed since Graham came up with the formula. Obviously it's not a one size fits all formula but it's an idea at least. Companies in general probably carry more debt, i.e. lower book value, and valuations based on P/E are typically higher as well compared to 50+ years ago so I think there might be a need for some revision to that. Sounds like a great idea for a post and I guess it's time to start some research for it.

      PEP and KO are great for the long-term, especially since both are offering between 3.2 and 3.3% yields right now. Those have been great entry points in the past and both companies are of the highest quality.

      Thanks for stopping by!

      Delete
  3. Great article, I'm seriously considering Pepsi for my next purchase. I'm going to have to re-read this article first. Thanks for sharing it.

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    Replies
    1. Captain,

      I'm glad you liked the article. I'm trying to get one up on DPS but the editors at SA are making a stink about some very nit-picky things. I've noticed it really depends on who does the editing as to how much they scrutinize every last detail. I added some more on Friday so I really like it's current valuation.

      Thanks for stopping by!

      Delete
  4. I've been holding Pepsi since I first began investing. It's definitely one of those "forever" stocks in my portfolio. If they keep on producing news like this past quarter, it'll be very nice to ride off into the sunset with them.

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    Replies
    1. First Million,

      I wish I had done the same when I first started investing. I agree that it's one of those forever stocks, especially with the huge stable of snack products. It's hard to go down the chips and snacks aisles at the store and not pick up one of their products.

      Thanks for stopping by!

      Delete
  5. It seems like the stock is on serious sale, based on your analysis. Do you tend to trust that Graham metric?

    ReplyDelete
    Replies
    1. Done by Forty,

      I think theres some good value in PEP right now.

      The Graham Number shows it to be quite overvalued but it does with most companies. Graham came up with the formula 50+ years ago so things have changed in the investment world since then. I have a feeling companies generally carry more debt and valuations as a whole are higher. So the traditional Graham number tends to undervalue companies. Im going to do a bit of research and hopefully get a post up about my thoughts on the Graham number.

      Thanks for stopping by!

      Delete