Pepsico’s (“Pepsi”) large brand portfolio can be found can be found in almost all grocery stores, convenience stores, stadiums, homes, etc. You get the picture. This brand is iconic. What else is great about Pepsi? It is a strong dividend growth stock with a long history of paying a dividend. While it is not quite an Aristocrat, Pepsi can be found in many dividend growth investors’ portfolios (including Lanny’s). So why not run Pepsi through the Dividend Diplomat Stock Screener and see if I will be adding any shares to my portfolio?
About Pepsi and the Company’s Brands
Pepsi is one of the two largest companies (Coke) in the snack and beverage industry. While I won’t list every brand the company owns, the company has some of the industry’s most recognizable brands. Have you heard of Pepsi, Lays, Mountain Dew, Gatorade, Quaker Oats, Doritos, Lipton, Fritos, Tostinos, Cheetos, and Ruffles*? All of these titans in the industry all fall under the Pepsi umbrella, which makes it unique compared to its competitors Coca-Cola and Dr. Pepper Snapple Group (“Dr. Pepper”) that are predominately beverage based. This diversification gives Pepsi a competitive edge over its rivals; having big time snack brands provides Pepsi another way into a family’s shopping cart and protects the company from any pop-industry events (yes, I call it pop and not soda). As you know, I am a big proponent of brands that find their way into every family’s house (I love and own Kraft and Procter & Gamble for that reason), so the more opportunities a Pepsi product has to leave a store in a grocery bag the better.
Dividend Diplomat Stock Screener
As discussed above, the diversification of Pepsi’s brand portfolio is a major competitive advantage for the company. Now it is time to look at the company’s financial performance and compare Pepsi to Coca-Cola and Dr. Pepper using the Dividend Diplomat Stock Screener.
Metric #1: Price to Earnings Ratio Less than the S&P 500
Currently, the S&P 500 P/E Ratio approximates 19.75 and changes on a daily basis. So we will use 19.75 for the purposes of our comparison. Using the September 17th, 2014 closing prices and the P/E and Forward P/E ratios listed on www.finviz.com, we created the table below. The table shows that the two major companies in the industry, Pepsi and Coke, are currently trading at a premium to the market while Dr. Pepper is trading at a slight discount. For that reason, Pepsi fails the first Dividend Diplomat metric while Dr. Pepper receives a pass rating.
Metric #2: Payout Ratio Less than 60%
It is critical that a dividend growth company has room to grow their dividend in the future. Sounds simple, right? As Lanny and I have learned the hard way, a dividend paying stock one day does not necessarily mean a company can always maintain the current dividend. We consider 60% a very healthy payout ratio to maintain the dividend distribution. If below, even better, as there would be tremendous room to grow the dividend payment. Luckily, as we can see below, all three companies have payout ratios below 60% with Dr. Pepper having the lowest of the group, a positive for all three companies! Pepsi’s payout ratio passes the second metric.
Metric #3: Dividend Growth
We like our dividend stocks to grow their dividend over time. A dividend increase below inflation results in a negative real yield, so ideally we look for dividend growth rates greater than inflation (~3%). The table below contains the average dividend increase for each company over the last five dividend increases. All three companies have growth rates in excess of inflation. While Pepsi only has a high single digit dividend growth, it is in line with the annual increase of P&G (Another mature consumer staple company) and is still greater than inflation. Therefore, Pepsi’s dividend growth rate passes the third metric.
Note: While Dr. Pepper’s growth rate appears much higher than Pepsi and Coca-Cola’s growth rates, Dr. Pepper increase their dividend from $.15 to $.25 five dividend increases ago. This caused the total to jump and all other increases were much lower. If removed, Dr. Pepper would have a dividend growth rate of 13.46% over the last 4 dividend increases. This is still greater than Pepsi and Coca-Cola, however.
Bonus Metric: comparing 5 Year Average Dividend Yield to Current Dividend Yield
A few months ago Lanny wrote about why he uses the 5 year average dividend yield to assess a dividend stock and compares the current yield to this average. Currently, Pepsi is yielding 2.82% and has an average 5 year dividend rate of 3.01%. So does this indicate a large dividend increase in the future? In order to increase their dividend to the 5 year average, Pepsi would have to increase their dividend by $.175 to $2.79/year or a 6.75% increase. This increase is in line with their average increase, so this could signal appropriate valuation. This metric could also signal the stock is slightly overvalued and a pullback would bring the current yield closer to the 5 year average yield. It would take a 6.65% decline in share price to reach $87.04 in order to increase the current yield to 3.01% (the five year average). If I had to give a firm answer at this moment, I would say it is a combination of both the anticipated dividend increase and a slight over-valuation of the stock.
Conclusion
So where do we go from here? Will I be adding Pepsi to my portfolio in the near future? Should I consider adding a position in Dr. Pepper instead since it performed better in the 3 Dividend Diplomat Metrics? The answer is no. While Dr. Pepper has better metrics, I do not like the fact the company’s brand portfolio is limited to soft drinks. It is a great company and I love drinking Dr. Pepper, but I want my initial purchase in the soft drink industry to be a diversified company like Pepsi. In regards to Pepsi, based on the P/E valuations and the Current Yield to 5 Year Average comparison, I would be purchasing a stock that is in the price range of slightly over-valued to properly valued. While I have purchased stocks that are over-valued in the past (PG for example), I do not have the excess capital to purchase this kind of stock at the moment. If I were sitting on excess reserves, I would strongly consider initiating a position in Pepsi. Since that is not the case, I will continue my search for undervalued dividend growth stocks. One day I will add a position in Pepsi, the timing is just not right now.
What are your current thoughts on Pepsi? Is it a stock that merit’s a premium purchase price? Am I crazy for not initiating a position in the company?
~Bert
Source of Brand Photos: Pepsico Website