Forget a taste test. The real battle between Coke and Pepsi has always been the fight for customer devotion and shelf space. Millions and millions of dollars were spent on this pursuit, and they often delivered the immense growth these two cola giants craved.
The North American economy over the past two years has forced them to change strategies, though. Rising raw costs led to price increases that were the only way to maintain margins and eke out returns. As a result, domestic growth came to a grinding halt. If Coke or Pepsi wanted bigger sales numbers, they had to look overseas or diversify into snacks.
Luckily for these two, commodity prices now are on the decline. That’s freeing up money the companies so desperately need for the promotions and customer pleasing that drives growth. This turn in the economy, while good news for both Coke and Pepsi, should benefit the latter even more, Cramer said. As PEP continues to outperform, he thinks big money managers will pay more for the company’s increasing earnings.
The educational take-home for viewers? P = E x M. The bigger the Earnings or the Multiple, the bigger the share Price. So the only two reasons you buy a stock in the first place is if you expect an upside earnings surprise or multiple expansion, which comes when institutional investors are willing to pay up for those earnings. Either way, the end result is a bigger P. It’s this multiple expansion that Cramer thinks will push Pepsi higher.
So where will those earnings come from? PEP pushed through price increases to accommodate the rising raw costs. Now that those costs have come down, the company will pocket the extra money made. That cash, as well as funds from Pepsi’s $1.2 billion productivity program, will go toward new promotions and products. Pepsi will spend about $3.2 billion on marketing and advertising alone to make sure these initiatives succeed. All of this should lead to increased sales and volumes, the two metrics professional money managers look at when evaluating a stock like this.
The stock trades at 14 times earnings, about 27% below its five-year average. While that might be in line with Coke, General Mills and Clorox, it’s a big discount to Alberto-Culver, Church & Dwight and Hershey. Given Pepsi’s strong prospects, Cramer thinks the stock should trade at a premium to the group. He said it will eventually, as long as the North American beverage business evens out as expected.
Cramer likes the 3.25% dividend yield, as well as the fact that most of Wall Street is sleeping on this stock right now. The market is much more concerned with tech, oil and the banks. But as soon as the big money sees Pepsi’s earnings acceleration, expect the company to get real popular, real fast.
Cramer's charitable trust owns General Mills and Pepsi.
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