When PepsiCo (NYSE: PEP) announced first-quarter results on April 23, the company self-titled its press release, "PepsiCo Reports Outstanding Q1 results -- EPS Surges 17%."

So much for modesty!

The results were outstanding for a company of Pepsi's size operating in an industry as slow-growing as food and beverages. And the strong earnings growth was not due to accounting benefits that large companies often use to massage the bottom line. Sales grew 8% and would have expanded double-digits if not for the negative effect of currencies, while operating profits grew 14%.

Like Coca-Cola (NYSE: KO), Pepsi largely succeeds or fails based on its marketing efforts. Of course, the products should have excellent brands, and product distribution channels that are more omnipresent than cockroaches are essential. But those qualities only help ensure steady sales. Effective marketing is what drives incremental sales, thereby creating growing value.

So, with these companies and others like them, keep a close eye on the marketing campaigns and the dollars spent. Is the spend resulting in higher sales?

Coca-Cola's marketing campaigns missed the mark the past four years. It has flat sales to show for it. Pepsi has grown sales 18% annualized since 1998. We began to consider Pepsi in 1999, and we started to purchase it in 2000. So far, we have purchased very small amounts because the stock hasn't appeared inexpensive, and because the pending Quaker Oats (NYSE: OAT) acquisition adds uncertainty and demands more homework.

We can read all about the first-quarter results at Pepsi and results at Quaker Oats from the press releases. Let's start to look beyond that.

Free cash flow valuation
Free cash flow is a company's lifeblood. It is the cash remaining from operations after capital investments. Essentially, it is the cash earned, and left over, with which the company can do anything it wants. Free cash flow at Pepsi and Quaker the past three years was:

                    Free Cash Flow
Pepsi             Quaker
2000   $2.84 billion     $236 million
1999   $1.90 billion     $408 million
1998   $1.80 billion     $308 million

Consider Pepsi: With an enterprise value of approximately $61 billion, Pepsi trades at 22 times its year 2000 free cash flow. This is still the least expensive free cash flow multiple that the stock has seen in a long time, even after the stock returned 43% in 2000 while free cash flow grew (not coincidentally) 49%.

Free cash flow in the first quarter of 2001, however, was negative $98 million. Luckily, the first quarter is usually lackluster on this measure.

In 2000, Pepsi's first quarter earned just $65 million in free cash flow, even though the year went on to produce $2.84 billion total. In 1999, first-quarter free cash flow was $91 million. The negative number to start this year is mainly due to a decline in operating working capital, a seasonal occurrence. So, excluding onetime events, free cash flow for 2001 could still (perhaps handily) top $3 billion. This means that Pepsi's stock is trading at a forward free cash flow multiple near or in the teens.

That forward multiple puts Pepsi at a 37% discount to the forward estimated free cash flow multiple of the average S&P 500 company, even though Pepsi is more likely than many others to achieve its numbers this year. In my opinion, this indicates that investors have not "caught up" with Pepsi's recent success yet, so the stock is bound to head higher. That, or investors are too obsessed with price-to-earnings multiples, even though free cash flow is a more meaningful metric.

Pepsi is expected to grow earnings per share 12% to 13% this year, before any boosts from Quaker, to about $1.64. The $44 stock trades at 26.8 times that estimate, making it appear more expensive.

(Note: Quaker's free cash flow for the first quarter isn't available yet.)

Pepsi in a can
Pepsi stated that the Quaker acquisition is moving as planned toward completion by the end of June, and management is confident in benefits that will occur. They believe that the acquisition will be immediately additive to both earnings and, presumably, free cash flow -- especially with cost cutting.

In my opinion, the stage is set for another few years of nicely rising free cash flow, meaning that Pepsi's stock is priced relatively conservatively, especially compared to its S&P 500 peers. There is no guarantee that Pepsi's stock will outperform the market (all mergers bring uncertainty), but the odds at least favor it. (Rule Maker recently wrote an excellent article on valuation and Coke vs. Pepsi.)

Drip's next investment
Every month, we invest new money in our companies by sending a check to one or more of their free dividend reinvestment plans. Next Monday, we'll send May's $100 to Pepsi. To discuss anything in this column, visit us on the Drip Companies board.

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Jeff Fischer owns all of the stocks in the Drip Port. The Motley Fool has a full disclosure policy.