Valuation and Investment Report
Investing, like most other things, requires investors to have a general philosophy about how to do things in order to avoid careless errors. Many people rightly believe when someone buys a share of stock, they are buying a proportional share in a business. As a result, to figure out how much the stock is worth, investors should determine how much the business is worth. Investors generally do this by assessing the company’s financials in terms of per-share values to calculate how much the proportional share of the business is worth. This is known as “fundamental” analysis by some, and most who use it view it as the only kind of rational stock analysis.
Our purpose is to know both the price and the value of a company’s stock. Our goal is to look at The Coca-Cola Company, PepsiCo. and Cadbury Schweppes for their intrinsic value; in other words, what the business would be worth if it were sold tomorrow. We are focused on the liquidation value of a company. This focus differs slightly in what it is what it might be worth if “all of its assets” were sold tomorrow, rather than the company as a whole.
However, value can be a very confusing label as the idea of intrinsic value is not specifically limited to the notion of liquidation value. For the purposes of this paper we have focused on the capital market, which is defined as: the broad term for the market where investment products such as stocks and bonds are bought and sold. It includes all the people and organizations which support the process. We will conduct Capital Market Ratio Analysis using the following: Price Earnings Ratio, Earnings Per Share, Dividend Yield, and common stock price. These indicate a company’s ability to win the confidence of the stock market.
The Coca-Cola Company (KO)
The Coca-Cola Company, a large-cap growth company in the consumer non-durables sector, is expected to outperform the market over the next six months with very low risk. With 10 being the best rating possible by MSN MoneyCentral’s StockScouter, The Coca-Cola Company scored 7, which relates to the stock being expected to perform in line with the market. According to Jon Markum (2004), “MSN Money built the StockScouter rating system to help individual investors quickly analyze and assess a stock’s potential for outperforming the broad market.”
He continues to state, it compares the fundamental and technical qualities of individual companies and their stocks to benchmarks that have proven statistically predictive of stock performance in the past. It then assigns an expected six-month return to each stock based on this statistical profile, and balances that return against expected volatility. This ratio of expected return to expected volatility, or “risk,” yields a stock’s final overall rating (2004).
The expected volatility, the author refers to is another term for “beta.” Portfolios with betas between 0 and 1.0 tend to move in the same direction as the market but not as far. The Coca-Cola Company (beta 0.3) has almost no unique risk and is relatively unaffected by market movements. Such a portfolio is .3 times as variable as the market. In other words, this number shows that a 10% jump in the index will result in an approximate 3% jump in stock return.
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).
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.