Coca-Cola And PepsiCo: Don't Let Short-Term Price Affect Your Long-Term Judgment

Jul.24.14 | About: PepsiCo Inc. (PEP)

Summary

Coca-Cola and PepsiCo recently announced quarterly earnings.

Afterwards, Coca-Cola shares traded a couple of percent lower while PepsiCo shares traded a couple of percent higher.

Many might see these moves as indicative of future results.

However, it’s likely that these short-term movements can cloud your long-term judgment.

Recently both Coca-Cola (NYSE:KO) and PepsiCo (NYSE:PEP) announced quarterly earnings. In my view: prices come daily, facts quarterly. That is, every second of every trading day the market provides liquidity bids for buyers and sellers; yet truly "new information" does not come along all that often. These quarterly reports can offer insight into the business's progress - the facts. But even then, the market's reaction can act as a smoke screen to the firm's underlying prospects.

We'll start with Coca-Cola. The Atlanta-based beverage behemoth posted "disappointing" results: $2.6 billion in profits based on revenues of $12.57 billion, for unadjusted per share earnings of $0.58 a share. Looked at from a slightly different perspective, Coca-Cola told you that it had 20% net margins, continued to pay its dividend (which has increased for 52 straight years) and increased book value by about 4% over the last 90 days.

So what did the share price do? Shares of KO traded lower by nearly 3% on the news, as it seems that many large holders wanted that revenue number to be a bit higher.

PepsiCo announced quarterly earnings the day after Coca-Cola. Within this release, PEP told you that it had a net margin of about 12%, continued to pay its dividend (which it has increased for 42 straight years) and increased book value by about 3% over the past 90 days. Expressed differently, PepsiCo "beat" earnings with revenues of $16.9 billion and net income of $1.98 billion. (Which, incidentally, made PepsiCo's revenue 34% higher than Coca-Cola's but its net income 24% lower)

So what happened to the share price? Shares of PepsiCo changed hands about 3% higher - as the company raised its guidance. You see it's all about expectations.

As such, you might be thinking that these price moves are noteworthy; that they provide lasting insight into the future. For instance, with PEP going up in price perhaps you believe the expectations have been "baked in" and now you've missed the boat. Conversely, seeing Coca-Cola shares bid lower, perhaps this is a signal that it's not quite the investment you once thought it to be. Personally I don't believe either, but I won't entirely rule out the possibility.

However, my contention is that these types of thinking can be a bit short-sided; that, especially in the present investing arena, it can be all too easy to fall victim to the whims of short-term price movements. On a single day a 3% move seems large. It's more than a year's worth of depository interest and if you were to extrapolate that gain or loss, then you better hang on to your hat. Yet the price and relative value of stocks rarely take linear form.

Further, if you pay too much attention to short-term price movements you could be giving away your biggest investing advantage: a long-term mindset. Allow me to create an example to illustrate what I mean.

Let's say that you have $100 to invest in a security quite like Coca-Cola or PepsiCo. For simplicity we'll say this fictional investment had a share price of $100 the day before it announced earnings. Your expectation is that it's trading at a fair valuation, it will grow by 7% a year and pay a $3 dividend that is expected to grow in-line with earnings. What the price of shares does tomorrow, next week or next year is anyone's guess, but you feel reasonably confident that the company will still be around 2 decades from now.

So what does this mean from a return expectation perspective? Well, if shares trade at the same multiple in 20 years and profits grow by 7% annually, this equates to a price of about $387 - a 7% yearly increase. Further, the $3 dividend would turn into nearly $11 in year 20, and a total of $123 in aggregate payments over the contemplated holding period. All in all, this would provide an 8.49% yearly return.

Yet what happens if you wait for earnings to come out? Well one of three things might happen: share price stays the same, share price goes up or share price goes down. Let's say the share price goes up, as in our PepsiCo example, by 3%. If you thought this was too high, you might not get the opportunity to purchase at a lower valuation (especially considering lost dividend payments). If you decide to buy - regardless of the 3% increase - here's what the results would look like: ending value of the initial c-note investment equals $376 for a 6.84% annualized price return and $119 in aggregate dividends for an 8.33% yearly return.

Finally, the price could go down as it did in the Coca-Cola scenario, which we'll call 3% as well. In this case, every $100 can buy more than one share and the end value over 20 years is about $399 - or a 7.16% annualized price gain. Additionally, the total dividends collected - $127 - would be greater as well for an 8.65% total annualized return.

Here's a summary of what that might look like:

When you buy:

3% Decline

Before Earnings

3% Increase

Begin Value

$100

$100

$100

End Value

$398.94

$386.97

$375.70

Price Return

7.16%

7.00%

6.84%

Dividends Rec.

$126.79

$122.99

$119.40

Total Return

8.65%

8.49%

8.33%

Click to enlarge

So obviously it's better to buy at a lower price - you end up with both higher capital appreciation and more income. Yet I believe the relative difference between the scenarios is eye opening. When you look at an earnings report - along with the corresponding stock price movement - it might be easy to say something along these lines: "Ah, 3% higher, I knew I should have bought yesterday" or "Gee, 3% lower, why couldn't I have just waited another day?" It seems like a big deal. However, if you take a long-term perspective, the relative difference fades over time. Assuredly it remains, but 0.15% annual discrepancies aren't going to crush a retirement.

Moreover, if waiting for a lower price inhibits you from ever buying, this could indeed create a lasting opportunity cost. That is, if waiting to buy at $100 again prevents you from buying at $103, then you could be trading a wonderful business partnership and the opportunity for 8%+ yearly gains for lesser alternatives.

If you're a truly long-term investor, then it follows that you likely don't care all that much about whether Coca-Cola earns $2.10 or $2.15 this year; your focus is on whether or not it'll earn say $8 a share 20 years from now while simultaneously expecting the dividend to increase at an acceptable rate. Looking at daily stock prices is fine, but don't allow the short-term price movements to affect your long-term investing judgment.

Disclosure: The author is long KO, PEP. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.