Two hours later, after ingesting Tums, we decided to conduct a taste test. Which product is more refreshing: a cold can of Pepsi, or a stick of Wrigley's Big Red? It was a close battle, but in the end Big Red won because rather than make your teeth brown and your mouth sticky, it cleans your teeth and leaves your mouth refreshed. So, based on this in-depth study, we may buy Wrigley stock. Then again, we may buy Pepsi instead. All right. We actually have issues with both investments.
As you may recall, in our food and beverage finalist study we booted Coca-Cola (NYSE: KO) out the door due to valuation and growth issues. The opportunities that we perceive at our other two candidates, Pepsi and Wrigley, are more attractive when we look through our super-powered (though not faultless) binoculars. However, the ensuing battle between Pepsi and Wrigley has hit a few roadblocks.
First, PepsiCo's business is in a transitional period. In trying to make an 18-year investment decision -- especially one that you must commit to slowly over time, month after month -- you want as much information as possible. It is very difficult to determine where key performance measures at PepsiCo are currently headed, including the measure of return on invested capital (ROIC). Until we see a few more quarters of operations under the company's still evolving business structure, it will be difficult to model where the company could be headed performance-wise. Until we have more visibility on things like ROIC, we would need to make more assumptions with Pepsi than we like to when embarking on a long-term relationship. The solution: watch the next few quarters closely.
Wrigley's business, on the other hand, is much easier to understand and to model. There aren't bizarre charges and credits clogging up the financial statements. Our issue with Wrigley is more specific. Our issue is the company's declining return on invested capital. As Brian and Spanky the Wonder Pooch showed us, Wrigley's ROIC has declined like a slowly landing jet each of the past five years:
1994 1995 1996 1997 1998
ROIC 28.5% 27.0% 26.6% 25.7% 23.6%
We assume that Wrigley's cost of capital is 11% (the historic return of the stock market), so the company is still earning more than twice its cost of capital, which is excellent. However, we would like to understand this trend well enough to predict when it will level off and perhaps rise again. As Brian explained, the company has been investing in new factories around the world. This increases Wrigley's capital base in assets that require time to generate the company's average long-term returns on capital. Hence, we see a slow (hopefully temporary) decline in return on invested capital. This may be too simplified, however, and we want to know what to expect of this figure in the intermediate and long-term. We will talk to Wrigley management next week and ask this question and others.
For now, this is where we stand on our food and beverage study: we need more time to see how Pepsi's new business model shakes out. We want to nail down Wrigley's ROIC projections. And we will watch Coca-Cola from afar. That's all simple enough, right? However, a brand new issue was introduced to this study this week -- an issue that may change everything.
Due to new online stock buying services such as BUYandHOLD.com, our universe of potential investments has expanded greatly. Having limited capital to invest, we want to make sure that there are not better investment options existing to us now, options that could replace Wrigley or Pepsi. We have an aggressive long-term goal, and we need to invest each dollar to maximize returns while restraining our exposure to undue risk. We have plenty to discuss as the direct investing landscape changes (and it does relate to our current study), so we will have more on this next week.
Touchstone Friday
We had myriad topics this week. On Monday, George discussed what Home Depot (NYSE: HD) is doing right. On Tuesday, we hypothesized on why the stock of Johnson & Johnson (NYSE: JNJ) has declined. On Wednesday, we redefined direct investing thanks to new online services that offer cheap investment in fractional shares. If you haven't read Wednesday's column yet, be sure to do so. Finally, on Thursday, Vince discussed investing in real estate via Drips. Yes, it is possible! To read these four columns, please see the links below today's column.
To close, Drip Port has had a rough few weeks as Intel (Nasdaq: INTC) and Johnson & Johnson have sunk faster than a German sub in 1945. We don't mind the decline. We'll probably send our next investment to both Intel and Johnson & Johnson equally, hoping that the stocks stay submerged at least until we buy. At $72, Intel trades at 31.7 times 1999 earnings estimates, and 26.9 times year 2000 estimates. This puts Intel at a discount to the S&P 500. If there is demand for it, we can discuss Intel's current situation (namely competition) in a column next week. Please post your interest in this topic on the Drip companies board (and share your thoughts on the issues, too).
At $94, Johnson & Johnson trades at 30.5 times this year's earnings estimate and 27.8 times year 2000 estimates. Finally, we recently bought more Mellon Bank (NYSE: MEL). We're still waiting for the confirmation slip. At $36, the stock is at 17.7 times year 2000 estimates. (You can visit Quote.Fool.com for all sorts of information on any public company.)
Have a great weekend!
--Jeff Fischer, TMF Jeff on the Fool boards
