My investment strategy

Today I will talk about my investment strategy.

This is a topic that I’ve explored before and most notably you can read about it here and here.

I’ve tried to do a graphic representation of the strategy and here it is:

As you probably already know I try to focus on small-cap stocks with high stable earnings and a good dividend yield.

Let’s go through the chart one point at a time:

1. Yield of 7 per cent or more. These prices are obviously only possible in highly depressed markets like the one we had during the financial crisis in early 2009. But if you find them congratulations as you will likely be earning splendidly from the stock in the future.
2. Dividend history. Here we are looking at the company’s history of paying out dividends. Is it good or bad? Has the company a history of increasing its dividend over time or has it been the same for the past fifteen years? Obviously we prefer a high that is also increasing over time.
3. P/E ratio of maximum seven. Because our goal is to maximize our gains we are constantly looking out for companies that are trading at low earning multiples. The lower the P/E ratio, the more value we will get. Now, obviously this is only true if the company has been making solid earnings over time and not making exceptional earnings one year only. According to famous investor John Lee, a “double seven” is a company with a P/E ratio lower than seven and a dividend yield of at least seven per cent.
4. Patience. This term comes from the fact that every investor should be able to wait for the value to come sufficiently to suit his or her book. The easiest task is in fact identifying the shares that are interesting. The most difficult is to wait for prices to come down.
5. Leverage. This term signifies financial leverage which should not be used excessively. One example where it can be used is if there is an interest rate spread between the money you borrow and the money you get in return from your investment. In that case it makes financial sense to borrow, but otherwise we would advice against it.
6. Integrity. This is where we are looking at the integrity of the business model when we are investing in a company. Many factors, such as trust between the founders and our clients, come into play when we are managing other people’s money.
7. Reinvest dividends. This is the ultimate investment trick. It allows you to compound your return for each dividend check and finally earn a higher return than if you had only counted on the price increase of, let’s say, a commodity.

Conclusion:

Today I have been talking about my investment strategy and how it translates into double digit earnings.

Hormel Foods

Fundamental analysis of Hormel Foods Corp. (ticker: HRL), May 26, 2017

Update October 31, 2017

Although prices have come down slightly since the beginning of August, the Hormel stock is still expensive.

It now trades at 18.4 times (2016) earnings.

Its expected forward earnings come in at $1.56 for 2017 which gives a forward P/E ratio of 19.3.

Hormel paid a dividend of 58 cents last year which seems to be increased this year to 68 cents.

At current dividends the yield is 2.3 per cent.

The cash flow yield for 2016 is 4.0 per cent. It is within the range of what you would expect for a company like this.

Conclusion:

While earnings and dividends are solid, I would still hesitate to buy stock of the company at these prices.

 

Update August 7, 2017

Hormel Foods is still expensive at 20.5 times trailing earnings. If we assume that the company will earn $1.60 this year the P/E multiple come in at a similar 21.0. The P/E over the average past three years is 25.1.

Because the company has a lot of intangible assets (these are to be subtracted from the equity to arrive at the book value) the Book value is negative.

The company has a working capital of $975 million which puts them in a good position.

The Free cash flow is $740 million which amounts to $1.36 per share. Of this they pay a dividend of $0.68 this year.

Conclusion:

While the company is still a little bit too expensive for my taste, it has got an interesting balance sheet.

Another good thing about the company is that it has solid earnings and a steady cash flow.

Hormel Foods has been paying out uninterrupted and increasing dividends for more than 25 years.

At these prices I would give it a HOLD.

 

 

 

Description:

Hormel Foods produces and commercializes various meat and food products. It is based in Austin, Minnesota.

 

Valuation:

The company is expensive at a trailing P/E of 21.5 and considering an average of the past three years’ earnings it looks even worse at 26.3. The Book value is negative due to the high Goodwill component of the Balance sheet which consequently gives a negative Price to Book value.

 

Balance sheet:

The Current assets to Current liabilities ratio looks good at 1.9 with a Net working capital of $975 million. The biggest problem for Hormel is its debt where the Debt to equity ratio is very high at 5.0.

 

Cash flow and dividend:

The Free cash flow last year came in at $735 million which equates to $1.36 per share. The Free cash flow allows the company to pay out a dividend 58 cents (1.7%). The dividend has been uninterrupted and increasing for more than 25 years which makes the part of the Dividend aristocrats.

 

Summary:

Hormel would be a good investment if it was about half the price, but now it is too expensive for me. I would not buy new stock at this point, but if you already own it by all means : HOLD.

 

 If you would like to learn more about fundamental analysis you can do that here.

Why improving your skills may lead to more luck

If you are a golfer you know that you don’t always the skills to hit the ball perfectly.

Sometimes you miss the ball ever so slightly and the results are horrible.

But sometimes the reverse is true – you miss the shot, but your drive still turns out all right and somehow it seems as though the better you get at the game, the more it happens.

How can that be?

Of course, if you improve your skills, the better at the game you will get. That’s a given.

So then when you hit the ball badly, you have practiced enough on your swing not to make a complete mess out of the shot.

That’s all very good, but what has that got to do with investing?

Quite a lot it turns out.

If you are getting into the habit of analyzing your stocks you will eventually acquire skills.

Those skills are crucial when it comes to determine if a certain stock provides good value or not.

When you decide to either sell or buy new stock of a particular company, you will realize that you are getting better at it over time.

What in the past may may have seemed as good decision will with improved skills rank lower and vice versa.

Conclusion:

The better you get at something the luckier you will get.

 

 

 

 

Stop wasting time

It is a dream of many investors is to hit a “ten bagger”.

A “ten bagger” is where you are making more than ten times your initial investment when exiting the investment.

Of course, it’s nice when it happens, but it’s important to remember that not all stocks have that potential.

During the course of your life you will be lucky to get 5 or 10 of those, maximum.

In most other cases stocks will be so overvalued that it will be virtually impossible to find a stock that grows as much.

The question then becomes what do you do when you can’t find any good investment opportunities.

To answer that question we first need to recognize that there are  many different investment strategies. You can for example look at the charts, at growth companies or you can buy them all in an index-fund.

But the one that I favor is one where you are buying great value at a decent price (and not the other way around).

That is the reason why it pays off in the long run to wait for the opportunities to arise. They always do.

So you may think that you are wasting your time when you are not buying, but it is not true. What you are really doing is that you are waiting for the price to come down to a more favorable point.

 

 

 

 

Technical analysis

Today I want to look at technical analysis of precious metals and other commodities.

Technical analysis of crude oil, October 1, 2017

This is a weekly chart of crude oil:

Description:

The chart is heading up towards the descending trend line and right now it sits just at it. From now on it will be interesting to see where prices will be going, if they go up or down. If they go up they could rise fast, but my hunch is that they will go down from here.

 

Technical analysis of gold, September 23, 2017

This is a weekly chart of gold:

Description:

The chart broke out of a descending trend line a few weeks back. Now it has hit the trend line again, but from the upside this time. We have to wait and see what happens on Monday morning, but normally I would consider this chart pattern being a buying opportunity.

Technical analysis of crude oil, September 14, 2017

This is a weekly chart of crude oil:

Description:

The chart is caught between two opposing trends: One descending trend line above and one lateral trend line below. Prices are now pushing up agains a rising 50-week moving average which makes a break-through likely.

 

The bullish scenario:

In this scenario prices go through both the 50-week moving average as well as the descending trend line above.

This scenario is fairly likely. I would give it a probability of 70 per cent.

 

The bullish/bearish scenario:

In this scenario prices falter at either the 50-week moving average or the the descending trend line. Given the chart pattern I don’t believe it being very likely. I would give it a probability of 15 per cent.

 

The bearish scenario:

This is where prices go south from here. I would also give such a scenario a probability of 15 per cent.

 

 

Technical analysis of gold, September 9, 2017

This is what a gold chart looks like:

Description:

We have a breakout!

Now there is nothing holding gold back and all the resistance is gone.

But would I be buyer at this stage?

Probably not. I would prefer to wait for a pull-back down at the descending trend line.

But essentially this is good news if you are bullish on gold.

 

Technical analysis of crude oil, September 3, 2017

This is what a chart of crude oil looks like:

Description:

We are still caught between the 50-week moving average and the 100-week. It looks as though the chart hasn’t really decided for which trend to follow.

The bullish case:

In this scenario prices bouncing off the 100-week MA and continue up through the 50-week and the descending trend line.

The bearish case:

In this scenario prices are falling through the 100-week MA and continue through the lateral trend line that is drawn in Figure 1.

I would give both these scenarios a probability of 50 percent at this stage.

Technical analysis of gold, August 24, 2017

This is what a chart of gold looks like:

Description:

The chart is squeezed between two opposing trends. The 100-week moving average is acting as support.

The bearish scenario:

In the bearish scenario prices falling down from here and then go through the rising 100-week moving average. I would give such a scenario a probability of 10 per cent.

The bearish/bullish scenario:

In this scenario prices are falling down to the 100-week moving average, but then they rebound and go higher. I would give such a scenario a probability of 30 per cent.

The bullish scenario:

In this scenario prices go through the descending trend line that is acting as resistance in the chart. I would give such a scenario a probability of 60 per cent.

Technical analysis of crude oil, August 17, 2017

This is what a chart of crude oil looks like:

Description:

Looking at the chart it becomes clearer to me that it is in a head-and-shoulders-pattern. The chart looks heavy.

The bullish scenario:

In the bullish scenario prices find their footing at the 100-week moving average and then move higher. Given the current chart pattern I would give such a scenario a probability of 15 per cent.

The bearish scenario:

In the bearish scenario prices along their current path and go lower. That means that they will penetrate through the 100-week moving average without any resistance. Given the chart pattern, I would give such a scenario a high probability of 85 per cent.

Technical analysis of crude oil, August 5, 2017

This is a weekly chart of crude oil:

Description:

The chart is getting squeezed between one supporting trend line (below) and another putting pressure on prices (above). Furthermore, there may be head-and-shoulders pattern building up in the chart.

The bullish scenario:

In the bullish scenario prices are supported by the 50-week moving average and move up through the descending trend line.

At this point I would put a ten per cent probability on that happening.

The bullish/bearish scenario:

This scenario is where prices move up and kiss the descending trend line but then move down.

I would give such a scenario a probability of ten per cent.

The bearish/bullish scenario:

This is where prices simply fall down and plunge through both the 50-week and the 100-week moving average. When prices finally hit the horizontal trend line then they rebound and continue within the trading range.

I would give such a scenario a probability of 75 per cent.

The bearish scenario:

In this scenario prices are simply plunging through both moving averages and then also the lateral trend line in the chart.

I would give such a scenario a low probability of 5 per cent.

Technical analysis of gold, July 31, 2017

As usual, this is a weekly chart of gold:

Description:

The chart is caught in a pennant like pattern with prices edging up against a declining trend line.

Prices are further lifted by the rising 100-week moving average (dotted turquoise line).

The bearish scenario:

In this scenario prices rediscover gravity and fall down from here.

That happens despite the rising 100-week moving average.

Because this is not very likely I give it a probability of 15 percent.

The bullish scenario:

In this scenario prices are moving up and through the declining trend line.

This is a likely scenario given the current chart pattern. I would give it a probability of 40 per cent.

The bullish/bearish scenario:

In this scenario prices move up and touch the declining trend line, but then fall down.

This is also a likely scenario and I would give it a probability of 45 per cent.

Technical analysis of gold, July 24, 2017

This is a weekly chart of gold:

Description:

The chart is in a classic pennant where it is pushing up on the descending trend line above.

 

The bullish scenario:

In this scenario prices go up from here, but they don’t stop at the upper trend line but continue through.

I would give such a scenario a probability of 50 per cent.

The bullish/bearish scenario:

This scenario is very similar to the one above.

The only difference is that prices stop at the declining trend line and continue down.

I would give such a scenario a probability of 40 per cent.

The bearish scenario

In the bearish scenario prices are rediscovering gravity and go down from here.

Because it is not very likely I give it a probability of 10 per cent.

Technical analysis of crude oil, July 19, 2017

This is a weekly chart of crude oil:

Description:

The chart is extending its right shoulder in a head-and-shoulders pattern. The chart looks heavy and I believe it will go lower from here.

The bullish scenario:

In the bullish scenario prices defy gravity and go up from here. I would give this a low probability of 5 per cent.

The bearish scenario:

In the bearish scenario prices go down from here. Given that the chart looks heavy I would give this a high probability: 95 per cent.

Conclusion:

The chart looks poised to go lower with a head-and-shoulders pattern developing.

Technical analysis of crude oil, July 13, 2017

Description:

The chart looks heavy with a left shoulder, a head and a right shoulder. This is usually a sign of the chart going lower from here.

Furthermore, prices are being pushed down by the 100-week moving average.

The bullish scenario:

In the bullish scenario prices defy gravity and edge higher from here.

I would give this a probability of 15 per cent.

The bearish scenario:

In this scenario prices are indeed being pushed down by the 100-week moving average.

Given the current shape of the chart, I would give this a probability of 85 per cent.

Conclusion:

My reading of the crude oil chart is that it is likely to go lower from here.

Technical analysis of gold, July 6, 2017

This is a weekly chart of gold:

Description:

The chart is caught between a descending trend line and a rising 100-week moving average.

The bullish scenario:

In this scenario prices are pushing up against the descending trend line and then through it.

Given the chart pattern I give this a probability of 65 per cent.

The bullish/bearish scenario:

Here prices are advancing up but then they go down at the trend line.

I would give this scenario a probability of 20 per cent.

The bearish scenario:

In this scenario prices are inexplicably going down from here.

I would give this a probability of 5 per cent.

The bearish/bullish scenario:

Here prices fall just like above, but when they reach the ascending trend line they change direction and head up.

I would give this a probability of 10 per cent.

Technical analysis of crude oil, July 1, 2017

This is a weekly chart of crude:

Description:

The chart is getting squeezed between two opposing trend lines. The one above is descending while the one below is lateral.

If we wait a couple of weeks we may see head-and-shoulders pattern forming.

The bullish scenario:

In the bullish scenario prices continue on their upward path that began this week (I didn’t believe that it would).

I would give such a scenario a low probability of 10 per cent.

The bearish scenario:

In this scenario prices are being pushed down the 100-week moving average.

I would give such a scenario a high a probability: 90 per cent.

Conclusion:

The chart looks bearish. We’ve tested the lateral trend line several times the past six months and in my opinion it will fall. The question is how deep.

Technical analysis of gold, June 26, 2017

This is what a weekly chart of gold looks like:

Description of chart:

Prices are now sitting on a declining 50-week moving average. If they go up from here they will face overhead resistance in the form of a descending trend line and if they fall they are likely to be caught by the ascending 100-week moving average below.

The bullish scenario:

In this scenario prices are being saved by the 50-week moving average that will act as support. After that they will then continue through the descending trend line.

This is an unlikely scenario because of the nature of the chart pattern.

I would only give this scenario a probability of 10 per cent.

The bullish/bearish scenario:

This scenario is as the one above with the difference that prices stop at the descending trend line and go down from there.

I give that scenario a probability of 30 per cent.

The bearish scenario:

In this scenario prices go down all the way through the 100-week moving average and the ascending trend line.

This is unlikely to happen but nevertheless I give it a probability of 5 per cent.

The bearish/bullish scenario:

In this scenario prices first fall but are then caught either by the ascending 100-week moving average or the ascending trend line below in the chart.

I would give such a scenario a probability of 55 per cent.

Technical analysis of crude oil, June 21, 2017

This is a weekly chart of crude oil:

Description:

The chart has been in a pennant until a few weeks ago. Now all the resistance in the chart is gone.

The bullish scenario:

In this scenario prices neglect gravity and head up from here without sensing any downward pressure.

While this scenario is not impossible, I don’t consider it likely.

I would give such a scenario a probability of 1 per cent.

The bearish scenario:

In this scenario prices go down because there is no resistance left in the chart.

At this juncture this is the likely scenario.

I would give such a scenario a probability of 99 per cent.

Conclusion:

It seems likely that we are going to fill up our cars cheaply this summer.

Technical analysis of gold, June 19, 2017

This is a weekly chart of gold:

Description:

The chart is in a pennant, currently on its way down, and once it breaks out of the resistance or the support, the move will be violent.

The bullish scenario:

In this scenario prices head up from here and break out of the resistance that is weighing on the upside.

Its not an unlikely scenario, but I would only give it a probability of 20 per cent.

The bearish scenario:

In this scenario prices go down from here. This is the more likely scenario given how prices have moved lately.

I would give such a scenario a probability of 80 per cent.

Conclusion:

In the short-term prices are likely to continue down, but in the medium-term it looks as though they are moving up. The reason why I say this is because prices have been knocking on the upper resistance zone at least twice recently. It would surprise me if they did not succeed to go through at some point.

Technical analysis of gold, June 12, 2017

This is what a weekly chart of gold looks like:

Prices sit just at the descending trend line and depending upon where they move from here will determine their movement for a long time.

The bullish scenario

In this scenario prices are slowly edging their way through the descending trend line.

If the resistance is gone prices have no immediate thing stopping them from much higher.

In favor of this is the fact that we are above both the 50-week and the 100-week moving averages.

Given the lower high made in February, I’d still give such a scenario a probability of 40 per cent.

The bearish scenario

In this scenario prices are headed lower from here.

The arguments for lower prices are the same as above.

I would give such a scenario a probability of 60 per cent.

Technical analysis of crude oil, June 09, 2017

This is a weekly chart of crude oil:

Summary:

Prices have now come down again and are now pushing against the ascending trend in the Figure 1.

The bearish scenario:

I will begin with the bearish scenario. This is where prices fall down through the ascending trend line and then continue down. At this point I would give such a scenario a probability of 65 per cent.

The bearish/bullish scenario:

In this scenario prices first go down but then rebound once they hit the trend line below. This is not implausible and I give such a scenario a probability of 30 per cent.

The bullish scenario

This is where prices shoot straight up from here. Given recent trends I don’t consider it very likely and I would give it a probability of 5 per cent.

Technical analysis of gold, June 05, 2017

This is what a weekly chart of gold looks like:

What we are seeing is that prices are coming up towards the descending trend line.

The bullish scenario

In this scenario prices are going through the declining trend line and then continue up beyond.

Given that the 100-week moving average is slightly ascending, I would give such a scenario a probability of 70 per cent.

 

The bearish scenario

In this scenario prices are going down from here.

While a distinct possibility, I only give such a scenario a probability of 30 per cent.

If you want to learn the basics of technical analysis you can do that here.

S & W Seed

Fundamenal analysis of S & W Seed Company (ticker: SANW), May 19, 2017

Update: 25 September, 2017

The company made a loss of $11.8 million last year which equates to -$0.67 per share. Despite of that the share is traded at $3.175 which is a lot of money. Last year the stock was trading at over $5.00. I’m not really sure that S&W Seed constitutes good value at present.

Update: 2 August, 2017

The company just made 2 cents per share last quarter. If this trend continues and S & W Seed makes 10 cents for the whole of 2017 the forward P/E ratio 34.5. The Price to Book value is still high at 2.5.

Looking at the Balance sheet things look a little better. The company has a Book value of $21 million which equates to $1.40 per share. The Working capital is $16 million which is good.

The company has a Free cash flow of $4.1 million which equals 27 cents per share. No dividends are paid out.

Conclusion:

Given the erratic earnings I would not be a buyer of S & W Seed at these prices.

 

 

Description:

S&W Seed Company is an agricultural company that is specializing in the breeding, growing and commercialization of alfalfa seeds.

 

Valuation:

SANW is expensive at trailing a P/E of 172. The average earnings over the past three years is looking even worse at a negative 6 cents.

Consequently the P/E ratio over the average three years is negative.

The Price to Book value is 2.5 which is high.

The earnings are to say the least erratic over the years. Last year they 2 cents per share and the year before the company had a loss of 25 cents per share.

The Shiller earnings since 2009 are a negative 4 cents.

 

Balance sheet:

Then we come to the balance sheet and here things looks a little better.

The Working capital is a solid $16,000,000 which equates to $1.08 per share.

The company has a Debt to equity ratio of 0.9 and a Current assets to Current liabilities ratio of 1.4.

 

Free cash flow and dividend:

The company has a good Free cash flow of $4,000,000, but they do not pay out any dividend which seems reasonable given their non-existent earnings.

 

Conclusion:

S & W Seed has great potential, but it is not an investment for me at current prices.

 

If you would like to learn more about fundamental analysis you can do that here.

My top 10 financial metrics

No matter how long you’ve been investing, there will inevitably come a time when you ask yourself if there’s a financial metric that is better than the others. What financial metrics can do is to help you to put a number on the value of a company.

So the question is, how do you find the best financial metric for your taste? If it’s already popular by other investors, you should also be able to use them, right?

Here are my 10 preferred financial metrics (listen in no particular order):

1. The Price to earnings (P/E) ratio. This is a classic when it comes to valuation. What you do is that you take the current market price of the stock and divide by the earnings per share. What you end up with is a number that tells you how much you are paying for the stock. The lower the number the cheaper the stock.
2. The Price to average earnings ratio. This is an alternative to the normal P/E ratio. What you do is that you take the current market price of the stock and then you divide the average over a given number of earnings. What I prefer to do is to look at the three years, but at least in theory, any number would do.
3. The Price to trailing earnings ratio. This is when you follow the stock in detail and know the exact each quarter. Then you can calculate a trailing P/E ratio even in, let’s say, the second, third and fourth quarter without estimates.
4. The Price to forward earnings ratio. This metric is similar to the one above but the difference is that instead of calculating the full four quarters earnings, you estimate next quarters’ earnings. I somehow prefer this metric to the one above.
5. The CPI-adjusted Price to earnings ratio. This deep value ratio can come in handy if you have a period of intense inflation that distorts the real value of the average. What we are doing here is that we are adjusting every earning with the CPI. What that gives us is a number that is adjusted for inflation. The problem with this kind of metric is that the business is likely to change during the ten years that we are looking at. I therefore prefer to only look at five years back.
6. The Price to book ratio. This is where you take the current price of your stock of choice and you divide with the book value. Now, the book value is calculated by taking the company’s total assets and subtracting its total liabilities and also the intangible assets that the company might have. If you are an observant reader, you will recognize that total assets minus total liabilities is what is called Shareholders’ equity.
7. The Free cash flow yield. The free cash flow is an important metric for calculating how much comes in and out of the company in given year. The metric is defined by taking the operational cash flow and then subtracting the costs that company infers for maintaining its asset base. The free cash flow yield then comes from taking the price of the stock and then divide by the free cash flow per share
8. Current assets to current liabilities. This metric tells you how much more current liabilities that there are in the company. The numbers for this can be either be found in the balance sheet of the company’s quarterly or annual report.
9. Debt to equity. This is where you compare the total liabilities that the company has to its equity. The number tells you something about if the debt load is high or low. The numbers for this can also be found in the balance sheets of the quarterly or the annual reports.
10. Return on equity. This profitability metric tells you how much profit the company makes in relation to the equity. The number tells you how good the company is at reinvest its capital. Personally, I prefer to see a ROE above 17 per cent in order to be happy.

Conclusion:

Today I’ve been talking about my favourite financial metrics. Have I missed any? Leave your comments below!

If you would like to learn more about this topic, you can check out my Guide to value investing for beginners.

Why is the Free cash flow yield important?

Today I want to talk about the Free cash flow yield and discuss why it is important for value investors.

In theory value investing is easy.

You buy an undervalued stock, you reinvest the dividends and you repeat for a long time.

The trouble is that you cannot be certain when the stocks that you are looking at are really undervalued – perhaps the company had just one year of good earnings that skews the Price to earnings ratio.

That is why I prefer to look at the Free cash flow. The Free cash flow is the amount of money that the company is making after paying off costs to maintain or expand the company’s asset base.

The Free cash flow is the money that the company can spend to pay dividends or to buy back shares.

OK, I get it, but what has this got to do with value?

Quite a lot, it turns out.

The Free cash flow per share complements the earnings per share and gives a broader picture of the money made.

Because it cannot be as easily manipulated as the earnings per share, it gives a fairer picture of how much money that flows into the company.

How do you calculate the Free cash flow yield?

First of all you need to find the Free cash flow. Go to the company’s web site and download the most recent annual report.

In there you will find something that is called Comprehensive cash flow statement.

You take the Cash flow from operating activities and you enter it into Excel. Then you will find something called Investment in plant, property and equipment. Then finally you add the two together, like so:

Then you need to find the number of shares that the company has outstanding and you divide the Free cash flow with this number.

Then it turns out that the Free cash flow yield is easy:

You divide the Free cash flow per share with the price per share, like so:

What you end up with is a percentage that you can use as a valuation metric.

In my experience, a free cash flow yield above 5 per cent indicates that the share is undervalued, if it is between 3 and 5 per cent it is worth considering and if it is below 3 per cent the share is outright expensive.

That is the reason why you want to consider the Free cash flow yield as another value metric.

Why not give it a go?

 

Pepsico, Inc.

Fundamental analysis of Pepsico, July 10, 2017

Update, September 12, 2017

Pepsico is valued at 26.5 times 2016 earnings which is expensive. If we assume that the company will be making $4.50 this year, which is in line with what they’ve been earning so far in 2017, the P/E ratio comes in at 25.7 which is still very expensive. The P/E over the past three years’ earnings is 28.2.

The Free cash flow yield comes in at 4.4 per cent which qualifies the stock in the “watch” category.

The only reason why you would want to own such a stock is the dividend of $3.06 per share (2.6 per cent yield). In an environment where you are getting 2.17% on a 10-year note this may be interesting for some people. However, as it stands the stock is too expensive for me.

 

 

Update:

The day after publishing this we figured out that the company presented their earnings.

The earnings came in better than anticipated and we can now make estimated guesses for next year’s earnings.

We think they will come in around $4.50 per share which equates to a forward P/E of 25.3.

That is still far too expensive for my taste.

Yesterday interestingly the share went down 0.5 per cent to $113.74.

Valuation:

At $115 and a trailing P/E value of 26.5 the PepsiCo share is expensive. Over a period of three years, the P/E ratio is even higher at 28.2. Because of their high degree of intangible assets the Book value is negative so a measure like Price to book does not make sense.

 

Balance sheet:

PepsiCo has a Working capital of $6 billion but the Working capital to debt is low at only 0.1. The Debt to equity ratio is extraordinarily high at 5.6.

In all, PepsiCo’s balance sheet could look better.

 

Free cash flow and dividend:

The company has a Free cash flow of $7.4 billion which equates to $5 per share. Of this they both buy back outstanding shares and pay a good dividend of $2.96 (2.6 per cent). The earnings look stable.

PepsiCo has been paying out uninterrupted and increasing dividends for more than 25 consecutive years.

 

Conclusion:

At 26.5 times trailing earnings PepsiCo is too expensive for my taste. At these prices I would call it a SELL.

 

If you would like to learn more about fundamental analysis you can do that here.

Discipline is having the strength to say no

What does it take to say no?

As an investor, you are more likely than not to have been in a situation like this:

You are listening to a presentation of a company that you are interested in.

The CEO is making his pitch and it is tempting. The business model sounds fool proof and you are on the verge of buying equity in the company.

But is it a good idea to buy just when you’ve listened to a presentation with a CEO?

Of course it is not. As always, you owe yourself some due diligence before making any investment decisions.

That is why I advice you to wait a week before buying if you’re tempted. If by then, it’s still a good proposition then buy. Otherwise you say no.

Why is it so difficult to say no?

As famous investor Benjamin Graham once said:

Every investment decision should be taken with safety of principal and a good rate of return in mind.

In the example above, the safety of principal is to say the least dubious.

There is simply no guarantee that you will be able to get your money back if you invest in an “interesting startup”. Additionally, the rate of return will almost certainly be non-existent in a speculation like this.

You don’t want to go there.

 

What you should do instead

You need to take an ice cold look at the prospect and not letting your feelings run high.

You need to carefully analyze the investment proposition looking at different key numbers from both the company in question and competing companies.

One thing that is extremely important is the earnings where a good investment is characterized by solid earnings. It makes no sense to invest in a company that is loss making.

If you after careful analysis come up with a negative outlook for the company, then you owe yourself to say no.

 

To say no is not a sign of weakness – it’s a sign of strength.

The more you look at different companies, the more experience you will acquire.

What that means is that you will look at many investment propositions before finally acting on one or two.

You will then be more secure in your decisions and not waste any money on useless propositions.

 

 

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