Valuation Ratios - Sample Essay

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.

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.