Hey, you know, if the Nasdaq continues to lose over 3% every day, in about two months it'll be near 0! Wow. Who would have predicted it!?
Now, today's serious topic is this: our food and beverage finalists, PepsiCo (NYSE: PEP) and Wrigley (NYSE: WWY). Over the past several months (see Drip Port archives), we have discussed most of the traditional performance and valuation metrics related to these two dominant, moderate growth and lower-risk companies. Today, we'll run both companies through a Motley Fool proprietary performance metric called the Flow Ratio.
The Flow Ratio was invented by Tom Gardner in conjunction with the Rule Maker Portfolio. The Rule Maker managers perform the Flow Ratio on potential investments and current holdings in hopes of finding a ratio of below 1.25. The lower a company's Flow Ratio, the better. In a nutshell, what the Flow Ratio measures is how well a company manages its cash accounts as shown by the balance sheet.
Rule Maker investors and Drip Port investors want to invest in companies that always have more money coming into the corporate bank at a faster rate than any money that is being paid out. For instance, accounts receivable should be collected more quickly than accounts payable are being paid. And, of course, the company must be paying out much less money than it is bringing in. Put into practice, the Flow Ratio makes it easy to measure cash management quality in regard to a company's balance sheet.
The formula for finding a company's Flow Ratio is:
(Current Assets - Cash*) Flow Ratio = ------------------------------ (Current Liabilities - ST Debt**) * Cash = cash & equivalents, marketable securities, and short-term investments ** Short-term Debt = notes payable and current portion of long-term debt
All of this information is best found from the company's latest SEC filings (available from http://quote.fool.com). Simply open the latest 10-Q from your company and go to the balance sheet. We've done that and compiled the above numbers for our two contenders. Now, when we run the Flow Ratio formula on our finalists, we arrive at the following results:
$3,777m - $520m = $3,257m PepsiCo = ------------------------- = 1.01 FLOW $3,474m - $278m = $3,196m $803m - $349m = $454m Wrigley = ----------------------- = 1.81 FLOW $251m - $0
The results indicate that PepsiCo is doing a substantially better job at bringing in cash on a timely basis and paying it out more modestly (or more slowly) than is Wrigley. That noted, the results do not mean that PepsiCo is necessarily running a better business. When it comes to managing cash on the balance sheet, though, it does appear to be doing so on this measure. (In the same breath, PepsiCo has $2.9 billion in long-term debt and Wrigley has zero debt. Only if Pepsi is generating a great return on investment is its long-term debt something to be proud of.)
For the record, Coca-Cola's (NYSE: KO) Flow Ratio was recently 1.04, and Microsoft's (Nasdaq: MSFT) -- perhaps the best one ever seen -- was recently 0.40.
When it comes to cash management, Brian Graney has suggested that Pepsi outperforms Wrigley because it has more places to reinvest its cash. For one, Pepsi is plowing money back into its Frito-Lay business. Already the number one salty-snack maker in the country, Frito-Lay recently introduced a new chip to compete with Pringle's. Meanwhile, Wrigley, as we've seen, apparently has fewer investment options and therefore is having more difficulty finding great places to reinvest cash. This makes us wonder where long-term market-beating sales and earnings growth might be found at Wrigley.
To learn all about the Flow Ratio and what it may portend, visit this page in the Rule Maker Steps. Next time I write, we'll run our two finalists through another Fool proprietary performance metric: the Cash King Margin.
To discuss this column, simply visit us on the Drip discussion boards linked below. Finally, if you'd like to grin, snicker, or laugh aloud right now, visit the Fool's new Fun & Folly area, and in particular, see this spoof news article on Amazon.com.
--Jeff Fischer, TMF Jeff on the boards.