Valuation Ratios
Valuation ratios of a stock assess whether a stock’s price is high or low relative to its current level of sales, earnings, and expected earnings growth. The valuation of the stock is dependent upon the price earnings ratio, earnings per share, dividend yield, and common stock price. The first consideration when computing valuation ratios is to evaluate the Price Earnings Ratio (AKA P/E). The P/E compares the current share price with earnings per share. Sometimes the P/E is referred to as the "multiple," because it shows how much investors are willing to pay per dollar of earnings. In general, a high P/E means high projected earnings in the future. However, the P/E ratio actually doesn't tell us a whole lot by itself. It's usually only useful to compare the P/E ratios of companies in the same industry, or to the market in general, or against the company's own historical P/E.
The Coca-Cola Company’s P/E is 23.9 (MSN Money Central) compared to the Industry’s 22.7 (Reuters, Industry Valuation) and the S&P’s 21.7. This shows that an investor is willing to pay $21.70 per dollar of earnings in the S&P Index. The Coca-Cola Company’s P/E is higher. If a company has a P/E higher than the market or industry average, this means the market is expecting big things over the next few months or years. A company with a high P/E ratio will eventually have to live up to the high rating by substantially increasing its earnings, or the stock price will need to drop.
The most important Per-Share Data item is Earnings Per Share (EPS). “EPS Excluding Extraordinary Items is the adjusted income available to Common divided by the diluted weighted average shares outstanding” (Reuters, 2004). It is most important because ultimately, the price of a company’s stock is related in some way to the value of the stream of earnings attributable to that share. EPS indicates the profitability of a company. To determine the quality of the EPS, it is recommended to rely on the operating cash flow. “High quality” EPS means that the number is a relatively true representation of what the company actually earned (i.e. cash generated). A low-quality EPS number does not accurately portray what the company earned. In our last paper we identified that Coca-Cola’s operating cash flow increased by 15%, while they realized positive earnings on the income statement (their Cash Flow per share is 2.26). According to MSN MoneyCentral, The Coca-Cola Company’s EPS is 1.89. This number is a high quality EPS telling investors that since the company generates a growing stream of operating cash flow per share it is a better investment than a company that posts increased EPS growth and negative operating cash flow per share.
A dividend is a cash payment from profits announced by a company's board of directors to be distributed among stockholders. In other words, dividends are an investor's share of the profits, given to him or her for being an owner of the company. The annual dividend is the total dollar amount of dividends the investor could expect to receive if he/she held the stock for a year (assuming no change in the company’s dividend policy). The dividend yield is the indicated annual dividend rate expressed as a percentage of the price of the stock, and could be compared to the coupon yield on a bond. The Coca-Cola Company reports a dividend rate of 1.00 in the last 12 months, a 5.99% increase in 5 years; and a dividend yield of 2.20%, a 5-year growth of 1.50%. As stated in our previous paper (10-K Report), in 2004 Coca-Cola increased their dividend for the 42nd year in a row.
The common stock share price has fluctuated with the market since the inception of our research. In week 2 of our class we conducted research for our industry stocks. Coca-Cola reported a closing share price of $50.53, only $3.50 less than the 52-week high and $8.25 more than the 52-week low. Today (July 26, 2004) the stock price closed at $44.30 (MSN MoneyCentral). The change is the stock price has stayed in line with the market. As the market drops, so does the price of this company’s stock. A significant change in this company’s stock could spark a change in the market due to the amount of holdings. Some of the Top 15 Institutional Owners include Bershire Hathaway (200 million shares held), Fidelity Management & Research Company (63.6 million shares held), Vanguard Group (50.5 million shares held), and JP Morgan Fleming Asset Management (24.4 million shares held).
Investment Advice
The reports are conflicting in regards to whether the investor should buy, sell, or hold this stock. According to results from Barchart.com for expected performance in the next 12 months, Long-term indicators reflect a 33% Sell (Overall average indicates 72% Sell). Reuters Analyst Consensus rates Cola-Cola as a Hold. This has been consistent for the past 15 weeks. Analyst Consensus from MSN MoneyCentral shows a Moderate Buy. Finally, Morningstar’s Analyst Opinions state that Coca-Cola’s average rating is 2.2 (1 = Buy, 5 = Sell). On our Learning Team we have a current Coca-Cola Company stockholder that feels that holding on to the stock would be the best decision at this time. The stock market is eventually going to recover and no large dips are expected. Since the history of Coca-Cola’s stock price has ebbed and flowed along with the market, it would be lucrative to hold on the stock until a much more profitable time to sell comes along.
PepsiCo. Inc. (PEP)
PepsiCo Inc. remains positive that their EPS (earnings per share) will be consistent with 2004 year end projections. The company is targeting earnings per share to be at least $2.29. Analysts project PepsiCo.’s year end earning per share will be approximately $2.30. Although the company has a positive Beta of .4, it still could use assistance with overall company performance. Since one or more analysts have predicted moderate increases over the next couple of quarters, PepsiCo Inc could increase the Beta to 1.0 which is suggested by stock buyers.
Valuation Ratios
A company’s stock price is divided by its earning per share for a 12 month period to calculate the price earning ratio. For example, the stock sells for $50 and is earning $5 a share, its P/E ratio is 10 (50/5). Most large positions have greater influence on a fund’s overall P/E due to the type of stocks the fund holds. Usually, P/E ratio provides information into valuation using an easy method; earnings. Stocks with high P/E’s comparing to the market are growth stocks, and low P/E’s are considered value stocks. Since earnings are volatile, the P/E is limited to the number of stocks disbursed at one time.
PepsiCo’s earnings per share for 2nd quarter 2004 has increased 12%. Pepsi’s P/E as of July 23, 2004 was $24.10 and earnings per share was at $2.10. This was largely due to increased volume in the international markets, solid price/mix across the North America markets, operating profits up 11% and net income up 12%.
Dividend Yield can be determined by various methods. A main calculation for companies to measure dividends is annual dividend per share divided by price per share. PepsiCo’s current dividend yield is at $1.80. Also, their dividend/share is at $0.92. They expect their year end dividend yield to be at least $2.29. The increase will be from operating activities of about $5.0 billion, and operating cash flow to be about $3.5 billion. PepsiCo continues their agreement to the shareholders through the return on cash agreement or share repurchase program.
Investment Advice
According to Barchart.com, the recommended stock analysis is to sell the stock at this time. This is largely due to Proctor & Gamble and Coca-Cola leading the industry at this time. With PepsiCo second to the number one beverage seller, Coca-Cola, Pepsi has made some changes to remain competitive within the beverage industry. In the U.S., Pepsi has restructured its beverage and food divisions creating five subdivisions named: Pepsi Cola North America, Juices, Gatorade, Quaker Foods and Canada. PepsiCo has also decided to streamline its process by cutting about 300 positions. Pepsi hopes to regain momentum by appealing to the low-carb lifestyle with its Pepsi Edge drink. Although Pepsi is confident of its Pepsi Edge drink, rival Coca-Cola has responded with its new product C2.
Another highlighting reason for sell activity on the stock market is due to the April SEC investigation with PepsiCo and Kmart. The investigation is allegedly looking into PepsiCo’s lower level employees who signed documents that caused Kmart to document increased revenue of nearly $6 million. Along with the SEC investigation and the rival, Coca Cola, PepsiCo has a challenging 3rd and 4th quarter remaining to impress the stock holders.
Finally, the stock analysis finds PepsiCo’s goals for 2004 a stretch due to the following remaining activities:
- Pepsi Edge, launched in June and competing with C2.
- Mountain Dew Pitch Black innovation ‘limited time only’
- Pepsi Play for a billion, game show on ABC in September
- TV advertising to increase sales for Aquafina
- Power of One promotions during the holidays
- Tropicana Pure & Light healthy drink
Over the balance of the remaining year, PepsiCo faces challenges of lapping success to Coca-Cola, SEC attention, and Proctor & Gamble becoming another rival for the beverage industry.
Cadbury-Schweppes (CSG)
Cadbury-Schweppes, the third largest company in the beverage industry, operates both as manufacturer and as a licensor of beverages and confectionary internationally. The company reported good performance over the first 6-months with weeks ending June 13, 2004 stating that it is meeting growth and earnings expectations primarily due to growth in the carbonated soft drinks business in the US, their UK confectionary business, and their major gum operations around the world. The growth in the US carbonated soft drinks is led by Dr. Pepper and their diet products. One of the hurdles the company faces is the inflation cost increases. Cadbury-Schweppes is optimistic about its second-half of the year earnings as it is implementing new projects, one being a greater focus on US confectionary.
Valuation Ratios
Cadbury-Schweppes’ price earnings ratio in July 2004 was below the industry average. It was 14.6 compared to the industry at 22.9. Its earnings per share (EPS) as of July 22, 2004 were $2.28. The earnings per share are estimated toincrease in 2005 to $2.42 according to MSN Money Central. The EPS growth rate of Cadbury-Schweppes (29.9%) falls below that of the industry (37%) and slightly below the S&P 500 (31.3%) when comparing year to date. However, when compared to its own EPS during the same quarter last year, it is up 64.3%, which is 27% more than the industry and 33% more than the S&P 500. The average growth over the past five years is 8.96%, slightly less than the industry, but higher than the S&P 500. Cadbury-Schweppes’ dividend yield is 2.6%. According to the company’s 6-month earnings report, their board has declared an interim dividend increasing dividends by 4% to be paid out on October 15, 2004 to Ordinary Shareholders. Their common stock share price is 33.37. Cadbury-Schweppes’ share price has increased by 41% over the last 12 months. They recently acquired a smaller confectionary company that impacted their working capital and cash; however the company has since shown increased revenues. On the other hand, according to the analysts alerts on MSN MoneyCentral, the “P/E to growth ratio suggests stock may be overvalued.” The share price is not expected to maintain the same rapid rate of growth as it was primarily attributed to the acquisition.
Investment Advice
Barchart.com and MSN Money Central provide opposing views on investment decision regarding CSG stock. Despite Cadbury-Schweppes’ current Beta (volatility) of .2, MSN Money Central advises to hold the stock. However, Barchart.com reports that the short and medium-term indicators recommend 60% and 50%, respectively, to sell the stock and the long-term indicator recommends buying the stock. Overall, it recommends, by 32%, to sell. In consideration of the company as a whole, the company is conservative and highly regards its values, ethics and employees. This provides a sense of security that the company is protective of its own shareholders and does not make impulsive radical decisions. They have a variety of products that provide diversification. Although it is not the stock to purchase for a quick income, over the long-term a financial gain can be made. This is a good stock for someone wanting to invest long-term without too much risk.
Conclusion
Valuation ratios or Capital Market Analysis Ratios are used to determine the relative attractiveness of a given stock based on its current price or market capitalization. A variety of benchmarks may be used, the most common of which is the Price/Earnings Ratio (stock price divided by annual earnings of each share of common stock outstanding). We reviewed several different factors, which included: price earnings ratio, earnings per share, dividend yield, and common stock price. Together with evaluating the companies’ betas and various other reports we have discovered neither Pepsi nor Coca-Cola are the industry leaders when it comes to this category.
According to Hoover's Online Business Information Authority, Cadbury Schweppes has the best valuation ratios, but simply because they focus more of their attention on the confectionary side since they have accepted the fact that they cannot compete with Pepsi and Coca-Cola in the beverage industry. Their valuation ratios show that the company looks like a good investment, if only analyzed on paper. For example, Coca-Cola is a strong company in the beverage industry, but the company’s P/E shows the stock is probably overvalued. This can be because whichever organization is closest to the industry (in terms of ratios) is the one that novice investors may perceive to be the best in the industry. If an investor simply judged their decision on the valuation ratios, they would not see the whole picture. They would need to dive deeper into their research possibly combining all the research this Learning Team has done over the past 5 weeks. The investor needs to consider the economy and the companies' abilities to recover after slumps in the economy, the industry as a whole, how their suppliers are doing, and then proceed with looking at financial statements, notes in the financial statements, and ratios. Once obtaining the best overall picture, the investor could make an informed, rational decision on where to place their investments.
References
Barchart.com (2004) KO, PEP, CSG Reports. Retrieved from
Camelback Research Alliance, Inc., (2004). MSN Money Central. Retrieved Jul 25, 2004, from The Coca-Cola Company, PepsiCo, Cadbury Schweppes: Stock Rating Summary Web site: ?.
Markum, J. (2004). Stockscouter rates potential reward, and risk. Retrieved Jul 25, 2004, from MSN Money Insight Web site:
Morningstar (2004). Quicktake Report: Coca-Cola Company, PepsiCo, Cadbury-Schweppes. Retrieved Jul 5, 2004 from Stock Analyst Reports Web site: .
Reuters(2004). The Coca-Cola Company, PepsiCo., Cadbury Schweppes Analyses. Retrieved Jul 19, 2004, from Investor Analysis Web site: .
