Tom Armistead

About the Author Tom Armistead

I'm a well-informed retail investor and post on SA in order to expose my thought process to critical examination and comment from readers. It makes me a better investor. I'm particularly proud of bullish macro articles posted in 2009 and later, in which I presented ideas that encouraged me to invest very profitably in a rising market. I also did articles on individual stocks, many of which contained insights not available elsewhere. Finally, I wrote a number of thoughtful articles critical of financialism and the lack of ethics on Wall Street. I do not post for compensation, as I am concerned that editorial policy encourages and pays a premium for articles that invite the reader to speculate on the short term movements of microcaps, penny stocks, and controversial issues. The best way for me to monetize my insights is to invest accordingly. As a retail investor, I don't give investment advice. I write about what I'm investing in, and the thought process involved in decision making and stock selection. Hopefully some of what I write is of benefit to others, by sharing my experience as I interpret it and helping them improve their investment thinking and process.

PepsiCo: Very Fully Valued


Shares of PepsiCo (NYSE:PEP) traded higher on 4th quarter earnings. After reviewing my worksheets on the company, I trimmed my position, and see no reason to own the shares at recent prices in the $100 area. This article covers the reasoning behind that decision.

Servings as a Metric

As a way of looking at total company underlying growth, PEP provides “servings” on a quarterly basis, which combines soft drinks and snacks. A serving is the amount cited in the mandatory nutrition information displayed on the packaging. Here’s a chart:

Information for the full year 2014 won’t be available until the 10-K is filed, so 9 months was used instead. Growth averages 3.5% for the period, but only 1.5% for the latest year and 9 months. Growth is somewhat erratic and seems to have slowed recently.

Incentives

The accounting for incentives is somewhat counter-intuitive: they are presented as deductions from revenue. The information is presented in the notes on the 10-K. Here’s a chart:

Demand Creation is the sum of Advertising and Incentives & Discounts. The big increase in 2010 to 2011 reflects the acquisition of Frito-Lay. It appears that incentives make up a very large part of the cash flow generated by snacks.

That has me asking a question: who owns the customer? When my wife shops for groceries, she buys our preferred brand of potato chips, if available. Otherwise, she buys whatever catches her eye. If I buy a snack at a convenience store/gas station, I pick more by the type of snack than the brand. One kind of barbecue chips is as good as another. Incentives reflect the cost of getting the merchandise on the shelf in front of the customer.

Based on this analysis, I don’t think brand equity is as high as the market seems to be pricing it.

PE5 Valuation

Based on an analysis of Price/5 year average earnings, the stock is very fully valued. Here’s how I did the math:

For many years, I used 20x as a target PE5 for stable high quality dividend payers, companies like Procter and Gamble (NYSE:PG) or Johnson & Johnson (NYSE:JNJ). Recently I revised that up to 22x to reflect current market realities and continued low interest rates. As a general rule, I buy below that multiple and sell when it is reached, with results that are acceptable to me.

Letting Go

I’ve been controlling PEP by means of options since 6/14/2013. For those who take an interest in options, here’s how I made out:

Shares of PepsiCo (NYSE:PEP) traded higher on 4th quarter earnings. After reviewing my worksheets on the company, I trimmed my position, and see no reason to own the shares at recent prices in the $100 area. This article covers the reasoning behind that decision.

Servings as a Metric

As a way of looking at total company underlying growth, PEP provides “servings” on a quarterly basis, which combines soft drinks and snacks. A serving is the amount cited in the mandatory nutrition information displayed on the packaging. Here’s a chart:

Information for the full year 2014 won’t be available until the 10-K is filed, so 9 months was used instead. Growth averages 3.5% for the period, but only 1.5% for the latest year and 9 months. Growth is somewhat erratic and seems to have slowed recently.

Incentives

The accounting for incentives is somewhat counter-intuitive: they are presented as deductions from revenue. The information is presented in the notes on the 10-K. Here’s a chart:

Demand Creation is the sum of Advertising and Incentives & Discounts. The big increase in 2010 to 2011 reflects the acquisition of Frito-Lay. It appears that incentives make up a very large part of the cash flow generated by snacks.

That has me asking a question: who owns the customer? When my wife shops for groceries, she buys our preferred brand of potato chips, if available. Otherwise, she buys whatever catches her eye. If I buy a snack at a convenience store/gas station, I pick more by the type of snack than the brand. One kind of barbecue chips is as good as another. Incentives reflect the cost of getting the merchandise on the shelf in front of the customer.

Based on this analysis, I don’t think brand equity is as high as the market seems to be pricing it.

PE5 Valuation

Based on an analysis of Price/5 year average earnings, the stock is very fully valued. Here’s how I did the math:

For many years, I used 20x as a target PE5 for stable high quality dividend payers, companies like Procter and Gamble (NYSE:PG) or Johnson & Johnson (NYSE:JNJ). Recently I revised that up to 22x to reflect current market realities and continued low interest rates. As a general rule, I buy below that multiple and sell when it is reached, with results that are acceptable to me.

Letting Go

I’ve been controlling PEP by means of options since 6/14/2013. For those who take an interest in options, here’s how I made out:

If shares close above $97.50 at expiration in April, I will have an IRR of 84.6% for a trade lasting almost two years. That’s quite a bit of leverage, compared to what could be achieved by owning the shares for the time period involved. I will be happy to close the trade if called away on the covered calls, or to continue it if shares are below $97.50 at expiration.

The funds liberated could be used to do a similar trade on any of several P&C Insurance companies that trade at a PE5 in the 10x to 12x area.

If shares close above $97.50 at expiration in April, I will have an IRR of 84.6% for a trade lasting almost two years. That’s quite a bit of leverage, compared to what could be achieved by owning the shares for the time period involved. I will be happy to close the trade if called away on the covered calls, or to continue it if shares are below $97.50 at expiration.

The funds liberated could be used to do a similar trade on any of several P&C Insurance companies that trade at a PE5 in the 10x to 12x area.