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Better Buy: PepsiCo vs. Verizon

By Reuben Gregg Brewer – Feb 22, 2020 at 1:23PM

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One of these dividend payers is a better value than the other, but is it a better buy?

It is virtually impossible to go through daily life in the United States without coming into contact with PepsiCo (PEP -2.01%) and Verizon (VZ -1.73%). They are, for the most part, ubiquitous entities that are a vital part of daily life. However, are their stocks worth buying? And is one a better choice than the other? Those are complex questions, but here's a primer to help you figure it all out.

1. Soda and snacks

From a top-level perspective, PepsiCo has a lot going for it. Although it has always played second fiddle to Coca-Cola in the soda space, it has a leading position in sports drinks, and its Frito-Lay business is the undisputed king when it comes to salty snacks. This strong and diversified core has allowed the company to increase its dividend annually for 47 consecutive years, placing it among a very rare group of companies. Its dividend yield, meanwhile, is 2.6%. While that's not exactly huge, it is more than investors would get from an S&P 500 Index fund today.   

Several bottles of products on a wood table.

PepsiCo makes much more than just its namesake soft drink. Image source: PepsiCo.

Unfortunately, there are a few problems with PepsiCo once you dig a little deeper. For example, leverage has increased materially in recent years. The company's financial-debt-to-EBITDA ratio has increased from roughly 0.5 times 15 years ago to around 2.5 times today. The soda and snack maker covers its interest expenses 11 times over, so it is hardly overleveraged. However, it doesn't have the same level of balance sheet flexibility as it did a decade or so ago. Now add to this that its cash dividend payout ratio is nearly 100%. Dividends come out of cash flow, so this metric, which compares dividends with free cash flow, provides a clearer view of dividend safety -- and it doesn't paint a satisfying picture. Dividend-focused investors probably won't want to buy PepsiCo today.   

That's not the end of the trouble, either. PepsiCo's stock is near all-time highs, and its dividend yield is at the low end of its range over the past decade. That suggests that it is expensive, too -- a fact that is confirmed when you consider the fact that PepsiCo's price-to-earnings, price-to-sales, price-to-book-value, and price-to-cash-flow ratios are all above their five-year averages today. Value-focused investors won't want to jump in here, either, it seems. That said, even the price-to-forward-earnings ratio, which uses future earnings estimates instead of historical earnings, is above its five-year average. So growth investors would be paying up for this stock, too, which diminishes its desirability.   

All in, PepsiCo is a great company, but it doesn't look like a great stock to buy today.

2. Getting ready for the next phase

Verizon's business is very different, since it is one of the largest cellphone carriers in the United States. That's a service that comes with monthly fees and tends to be fairly sticky. The telecom also has some legacy businesses, left over from when it was predominantly a landline carrier, notably including its Fios internet and video services. Again, these are fee-based and sticky. So it should be little wonder that Verizon has been able to increase its dividend annually for 15 years. The stock's yield, meanwhile, is a generous 4.2%. Dividend investors will clearly find that more attractive than what's on offer from PepsiCo, but don't jump on board just yet.

Verizon's financial-debt-to-EBITDA ratio was around 1.2 times at the start of the century but is now 2.5 times. It operates in a very capital-intensive industry that's on the cusp of unveiling new 5G technology. So it's likely that leverage will spike even higher from here in the next few years. It covers its interest expenses by about six times, which is adequate, but not great. Its cash dividend payout ratio, meanwhile, is around 60%. That provides room for growth and is much better than PepsiCo, but that coverage is likely to weaken as Verizon spends on 5G upgrades. It's not exactly a screaming buy for dividend investors.   

PEP Financial Debt to EBITDA (TTM) Chart

PEP Financial Debt to EBITDA (TTM) data by YCharts.

That said, valuationwise Verizon looks a lot more attractive than PepsiCo. Although Verizon's price-to-sales ratio is above its five-year average, its price-to-earnings, price-to-book value, price-to-cash-flow, and price-to-forward-earnings ratios are all below their averages. Countering these facts, however, is a stock that is near all-time highs and a yield that is about in the middle of its long-term range, so it really doesn't appear to be a screaming buy valuationwise... just a better value than PepsiCo.  

But there's one more fact that's worth considering here. A few years ago, Verizon's management team thought it would be a good idea to buy one-time internet giants AOL and Yahoo!. The hope was that by combining these two now-troubled brands, Verizon could create a strong competitor in the content space. It didn't work and was, largely, a managerial distraction and waste of shareholder money. That's a misstep that should worry most investors. 

No good options?

PepsiCo and Verizon both have strong core businesses. They aren't bad companies, but neither really stands out as a great investment option right now. Of the two, Verizon is more attractive in terms of dividend and valuation. But it is still hard to suggest investors run out and buy the shares. There are better income options on Wall Street, notably in the out-of-favor midstream energy sector. In the end, investors should probably take a pass on both PepsiCo and Verizon.

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Verizon Communications Inc. Stock Quote
Verizon Communications Inc.
$37.97 (-1.73%) $0.67
Pepsico, Inc. Stock Quote
Pepsico, Inc.
$163.26 (-2.01%) $-3.35

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