Seeking Alpha
Long/short equity, contrarian, currencies, hedge fund analyst
Profile| Send Message|
( followers)  

Basics of the research

This article presents a research on the PepsiCo, Inc. (NYSE:PEP) stock. It is the fifth one from a series which examines some risk and reward characteristics of several well known dividend paying stocks - Johnson & Johnson (NYSE:JNJ), Coca Cola Co. (NYSE:KO), Procter & Gamble Co. (NYSE:PG), Chevron Corp. (NYSE:CVX) and PepsiCo, Inc. Subsequent articles are built on the previous ones so readers could expect to find more information and stocks comparisons as the number of articles grows.

The first four articles covered Johnson & Johnson, Coca Cola, Procter & Gamble and Chevron.

The main purpose of the analysis is to provide information about the historical risk, and especially the tail risk, which is present in a stock's distribution of total returns. Tail risk is the risk of getting returns which stand as far as several standard deviations from the mean. In order to make an informed decision, an investor should compare the tail risk of several similar investment opportunities. Tail risk could have a significant effect on a stock's return, mostly because of its potential magnitude. By definition, such tail returns are a rare event. The potential problem appears if the tail risk materializes in a period in which investors expect a withdrawal from the portfolio to happen. This could disturb financial strategies and depending on the leverage used, it could have serious consequences on financial stability of the entities involved. The tail risk is represented by two characteristics of the distribution of returns - skewness and kurtosis.

Skewness

Regarding the long-run risk of loss, a positive skewness is sometimes the preferred one. The reasoning behind this view is that the positive skewness incorporates a higher historical probability that a large unexpected return would be on the positive side, i.e. larger than the mean. On the other hand, a negative skewness presents a higher probability of an unexpectedly large negative return during some period. Hence, it shows an increased risk concerning the available capital at the end. For a better understanding the reader could use the classic explanation where the negative skewness is compared to picking up nickels in front of a bulldozer. The large unexpected negative return comes with the bulldozer's move.

Kurtosis

The kurtosis as a measure of risk indicates whether the return distribution experiences fat tails. Those are major risk descriptors which show whether there is a larger than the normal probability of having returns far from the mean, both positive and negative. For instance, a kurtosis value of zero shows there is no such higher-than-normal probability. We should note that by 'normal' we mean the probability presented in a normal distribution of returns and not the returns of some particular benchmark index.

For more information, readers could check the Johnson & Johnson analysis in which the skewness and kurtosis were explained in more details.

The total return of a stock is a sum of its price change and the cash flow which investors get on a regular basis, basically in the form of dividends. Because dividends and share repurchases are a major part of the examined stocks' total return, a special attention will be paid to risk on cash distributions.

The current research of PepsiCo, Inc. covers returns data from the last 36 years. As with the other examined companies, this long period includes several different economic environments and cycles, both good and bad ones. Hence, the calculated long-run coefficients could be expected to be relatively free from sampling biases and closer to the true descriptors of the stock's population of returns.

Nevertheless, the readers should keep in mind that historical performance does not guarantee future results.

Readers should also account for the mean reversion tendency the returns generally exhibit in time. As mentioned in the first article, the performance in the more recent periods, i.e. the last 12 months or last 5 years, could be more important and useful for the moment but it would tend to get closer to the mean characteristics of the longer time frame periods, given that no significant change in the economic environment or the company itself has happened.

The Companies Selected

The companies selected for the analysis have a long dividend distributing history. Moreover, they have increased the dividend size in almost each of the last 40 years. The history of PepsiCo shows that it has distributed dividends in all of the last 36 years.

The average yearly dividend increase for PepsiCo for the last 36 years amounts to 9.12%. For comparison purposes, the values for the respective periods for JNJ, KO, PG and CVX are 14.75%, 10.75%, 10% and 10.7%, respectively.

During the last 5 years the companies also distributed wealth to their shareholders through share repurchases. Generally this increases the demand for stocks and has a positive effect on their price. If at the end of the fiscal year the company has a different amount of basic shares outstanding than at the beginning, this change could also affect the size of the dividend paid and the payout ratio.

PepsiCo Stock's Characteristics and Analysis

PepsiCo, Inc. is an U.S. based company which operates in foods and beverages business sectors worldwide. It was founded in 1965 and is headquartered in Purchase, New York.

PepsiCo Inc.

Comparison with Johnson & Johnson, Coca Cola, Procter & Gamble, Chevron and S&P500

The Compound Annual Growth Rate (CAGR) based ranking between the examined companies goes like this:

We see that PepsiCo provided the best compound annual growth rate for the examined period in the group. The last January decline in the U.S. equity markets did not have such a big impact on the PEP stock as on the other examined stocks. The following table shows a comparison between the January 2013 and January 2014 movements of the market:

We see that PEP moved almost inline with S&P 500 during January, 2014. This is close to the stock's behavior for the last year where its beta regarding the general market stood at 0.84. Therefore, with a certain degree of confidence we could expect that the stock will continue to resemble the performance of the S&P500 index in the near future. Moreover, such a change of -3.1% is fairly often met in the stock's performance so it does not present an outlier in the population distribution and can hardly be used as a source of risk analysis.

Comparing the graphs of adjusted monthly prices, we see that apart from the differences in KO's price behavior which were commented in more details in the Coca Cola analysis, all the companies seem to be in a long term uptrend. The last major decline of PEP was during the January 2008 - June 2009 period, where PEP declined by about 24%. For the same period S&P500 lost about 38% of its value. During the previous major crisis, in 2001-2002, the stock's price was slightly affected because of differences in the underlying causes of the crisis.

PepsiCo undertook 4 stock splits in the examined period - in May 1977, May 1986, September 1990 and May 1996. The prices at which the stock experienced a split were between $63 and $87. This range is close to the current price of PEP.

Regarding the risk adjusted price return for the whole examined period, the PEP stock stands at the top compared to the other four companies and S&P500. The Sharpe ratio of PEP is 0.22 against 0.19 for both PG and JNJ, 0.18 for both KO and CVX and 0.17 for S&P500. This shows PepsiCo's stock as the most profitable stock in the examined group regarding the risk adjusted returns.

Analysis of Risk on Dividends and Cash Distributions

Because the total return consists of a price and a dividend return we should also examine the risks on the dividend portion of the total return.

Similar to the other companies examined, PepsiCo has steadily increased its dividend size during almost all of the examined years. The average annual growth rate for the last 36 years is 9.12%. This is the lower one in the group.

The projected dividend for 2013 (see the table 1 above) seems realistic but might put some pressure on the company's financial results. It implies a dividend growth rate of about 8.4%. This is below the average dividend growth rate for PepsiCo (9.12%) but above the growth rates from the last two years which stand around 5%. Hence, we could consider expectations of an increase of the dividend of this magnitude to bear some risk because a higher dividend growth rate might put pressure on the company's financial stability. The company may prefer to stick to a lower payout ratio in order to have safety buffers in case of a need.

The payout ratio of PEP is the highest one in the examined group of companies. The cash distribution ratio, which includes dividends and share repurchases, is the second largest in the group. All other things equal, these present PepsiCo as a company with a higher level of risk concerning the cash distribution to shareholders compared to the other examined companies. Still those characteristics should not be used in isolation because by distributing so much cash to its shareholders, the company effectively lowers the price risk of its stock. A potential problem could arise in a situation of an increasing cash distribution ratio and a lower net income.

Another risk characteristics

Examining the whole period of 36 years we see a returns distribution with a slightly negative skewness and a significant excess kurtosis. The negative skewness (-0.17) speaks of a higher-than-normal historical risk of an unexpected negative monthly return which would stand far from the mean value. Of the examined stocks and S&P500, only CVX has a noticeable positive skewness. All the others exhibit a negative (KO, PG, SPX) or close to zero skewness. PEP's skewness puts the stock between PG and KO regarding this characteristic.

The kurtosis (1.96) is the third highest in the group. Only PG and CVX exhibit higher kurtosis for the whole examined period. Such a kurtosis shows a distribution with fatter tails, both compared to the normal one and to the distributions of the remaining two companies and S&P500. The fatter tails present an increased probability of having extremely large returns on both sides of the mean, generally. The combination with a negative skewness suggests more of those surprising returns could be lower than the mean.

The closer time frames do not change significantly the situation regarding the skewness but the kurtosis becomes smaller and the stock behaves more in line with the S&P 500 which is suggested by the correlations and beta. The negative skewness remains so unexpected results below the mean should not be a big surprise.

Because of the mean reversion tendency which the characteristics of the returns generally follow, we could expect that the more recent descriptors would converge to the longer term ones. If the long-run coefficients are indeed closer to the true population descriptors, we should expect the recent risk characteristics of PEP to gradually revert to the longer-run values. In the case of PEP this could benefit the stock's risk characteristics regarding the skewness by reducing the probability of having large extreme returns below the mean.

Source: Risk And Reward Analysis Of 5 Dividend Stocks - Part V: PepsiCo, Inc. In Focus