ALEXANDRIA, VA (Sept. 1, 1999) -- Between Jeff's recent columns and the work of dozens -- perhaps even scores, as honest Abe would say -- of Fools on the Drip Companies message board, we seem to have Wrigley's (NYSE: WWY) bases covered pretty well.
We know the company is the chewing gum king and has been planted on its throne for more than a century. We also seem to agree that the company still has some growth prospects lingering out there in terms of new markets and new product opportunities. What really hasn't been addressed sufficiently, though, is how much this big, gooey ball of gum is worth. Leave it to Jeff to dump the hard homework on me.
"Now see here!" Jeff bellowed in my general direction at the beginning of this food and beverage study. "I'll figure out if it's a good business or not. You figure out the price tag, maggot!" he ordered, doing his best impression of a Paris Island drill sergeant. So, after dropping and giving Jeff twenty, I jumped right into Wrigley's financials.
To start, I chose to look at Wrigley through the valuation prism of return on invested capital (ROIC). I use the term prism for a reason, since ROIC is a great way for investors to focus what's happening simultaneously on the balance sheet and on the income statement down to a single figure. That figure can then be matched against ROIC figures for prior periods or against ROIC numbers for other companies.
ROIC has its limitations and should be treated as just one of the many instruments to have in your investing toolbox, along with a hacksaw and a good set of eye goggles. It's not a valuation silver bullet. But it is useful, and long-term investors should take the necessary time to become comfortable with the concept. Veteran Drip Port readers should be familiar with ROIC from past studies. But for the newcomers out there, a useful introduction is the Fool's five-part series on ROIC, which was penned by our very own Dale Wettlaufer in an even 47 minutes -- still a Fool record.
To figure out ROIC, we divide net operating profits after tax (NOPAT) by total available invested capital. Unfortunately, these figures are not broken out in Wrigley's financial statements, or in any other company's statements for that matter. They have to be calculated by the analyst (that's Drip Port techno-jargon for YOU). Rather than include all of my calculations here, I'll provide them in detail in a post on the Drip Companies board along with the assumptions that underlie them. Your assumptions may differ, of course, mostly because I have a nagging tendency to simply make things up as I go along.
I crunched the numbers myself since Spanky the Wonder Pooch, our longtime resident statistician, took an ill-timed trip to Jamaica this week. I ended up with the following ROIC figures for Wrigley over the past five years:
1994 1995 1996 1997 1998 ROIC 28.5% 27.0% 26.6% 25.7% 23.6%
As you can see, ROIC has been gradually diminishing, like the flavor of a stick of Juicy Fruit. That's not the greatest trend in the world, but it's not a total disaster either. Even after last year's drop, Wrigley's ROIC is still twice its cost of capital.
What's that mean?
Since Wrigley is virtually 100% equity financed without a lick of long-term debt, we assume the company's cost of capital is 11%. That's the minimum return Wrigley shareholders can be expected to demand for their invested dollars, which is in line with the historical average rate of return for the S&P 500. In other words, if Wrigley fails to return at least 11%, then investors would have been better off stashing their money in an index fund.
Since Wrigley is a class act of American business, it's not very surprising to learn that there is a decent spread between the firm's ROIC and its cost of capital. What is worrisome, however, is that this spread has been diminishing recently. We'll take a closer look at the reasons for the erosion and meet ROIC's little brother, return on marginal invested capital, tomorrow.