When Donald Yacktman makes an investment, investors should take note. Yacktman's two mutual funds -- Yacktman Fund and Yacktman Focused Fund -- both receive Morningstar's 5-star rating for risk-adjusted returns for the last three, five, and 10-year periods.
Yacktman achieved his success by paying reasonable prices for companies that produce gobs of free cash flow. Recently, he has been adding to positions in Avon Products (NYSE:AVP), Coca-Cola (NYSE:KO), and PepsiCo (NYSE:PEP); the three companies now make up more than 20% of his portfolio. Yacktman's confidence should make long-term investors take a closer look at these three companies.
Contrarian bet on multilevel marketer
Avon is a multilevel marketing company that sells beauty, fashion, and home products in 62 countries through independent sales representatives. Yacktman increased his stake in Avon by one-third during the first three months of 2014; it now represents 1.5% of his overall portfolio.
Yacktman's purchases came just months before Avon disclosed a $135 million settlement with the U.S. Department of Justice for violating the Foreign Corrupt Practices Act. The government's investigations into claims that Avon's Chinese subsidiary offered bribes to local officials had been an overhang on the stock for years. Although the $135 million settlement is nearly one-third of Avon's 2013 operating income, the elimination of uncertainty regarding the ultimate settlement could go a long way toward righting the stock.
Declining revenue is also weighing on Avon's stock price. The stock price hit a 52-week low on May 1 after the company reported an 11% decline in first-quarter revenue. The company is struggling to recruit new sales representatives to replace departing ones, causing sales to fall. However, the company's capital-light business model enables it to generate lots of free cash flow -- more than $500 million per year. At 17.5 times 2013 free cash flow, Yacktman clearly sees upside in this turnaround story.
Coke or Pepsi? Yacktman says both
Coca-Cola and PepsiCo are both featured in Yacktman's portfolio. PepsiCo is Yacktman's largest position, representing 11.5% of his overall portfolio. Coca-Cola is a 7.2% position, Yacktman's fourth-largest position. Both of these companies are classic Yacktman investments: They trade at a reasonable multiple of free cash flow and have durable competitive advantages.
Yacktman may favor PepsiCo over Coca-Cola because it has a great snacks business that provides diversification away from the embattled soft-drink business. Although Yacktman's position in Coca-Cola indicates that he has high hopes for the soft-drink market, there is no question that PepsiCo's snacks business is better than the soft-drink business. Frito-Lay is enormously profitable; Frito-Lay North America generated a 27.5% operating margin in 2013, besting PepsiCo Americas Beverages' 11% profit margin. It also tops Coca-Cola's worldwide operating margin, which came in just below 22% in 2013.
Although earning higher margins makes Frito-Lay an attractive asset, its growth is the most attractive aspect. PepsiCo's snacks volume grew 3% in 2013, far outpacing its 1% beverage growth. It also beat Coca-Cola's 2% global volume growth in 2013. Clearly, PepsiCo has a valuable asset in its snacks business.
In addition to a durable competitive advantage and good future prospects, Yacktman demands a high initial free cash flow yield. In a low interest rate environment, PepsiCo's 5.2% initial yield and Coca-Cola's 4.8% initial yield are reasonable for two of America's biggest cash cows. After moderate growth, the stocks could produce high-single-digit returns for long-term investors.
Donald Yacktman is one of the greatest long-term investors of our time. Although blindly following superinvestors into individual stocks is not recommended, taking a close look at Yacktman's recent stake increases is a good way to uncover promising long-term investments. As a result, enterprising investors should research Avon, Coca-Cola, and PepsiCo to see what makes them attractive to such a great investor.
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Ted Cooper owns shares of Coca-Cola. The Motley Fool recommends Coca-Cola and PepsiCo. The Motley Fool owns shares of PepsiCo and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.