PepsiCo: A Stock for the Ages

You can drive yourself nuts if you let news developments steer your investment decisions. Oil prices are plunging; is it time to dump your energy stocks? Interest rates may have peaked; should you load up on the deflated homebuilders? Emotions take over. Brokers don't help matters by issuing a steady stream of buy and sell notes (well, occasionally they tell you to sell) that may seem designed to pump up their commissions.

What if you could buy and hold stocks, and pretty much ignore the news? That's essentially the principle on which Jensen Portfolio constructs its fund. Jensen searches for high-quality growth companies, businesses that perform year after year. On average, Jensen holds stocks in its highly concentrated portfolio for seven years, which is a lifetime by mutual fund standards.

One stock that attracts Jensen co-manager Eric Schoenstein is PepsiCo, the big snack-food and beverage company. Here's why: Jensen only holds enterprises that generate a return on equity, a measure of profitability, of at least 15% for ten straight years and throw off a high level of recurring free cash flow (net profits plus non-cash charges such as depreciation, minus capital expenditures). The reasoning is that businesses that demonstrate these numeric characteristics have sustainable competitive advantages that hold up through the ups and downs of business cycles.

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So how does PepsiCo stack up? ROE for the company, which owns such well-known brands as Frito-Lay and Quaker Foods, is a towering 32%. The Purchase, N.Y., company generates in excess of $4 billion of free cash flow each year -- money it can use for acquisitions or return to shareholders in the form of dividends or share buybacks. Over the past decade, earnings per share and dividends have compounded by 10% per annum, a growth rate implying a 160% return for buy-and-hold investors. "It's remarkable how consistent Pepsi has been," says Schoenstein. "They do well in any economy."

But what does the future hold? Schoenstein thinks overseas expansion will be the key driver. PepsiCo gets only 35% of revenues from abroad, less than half the ratio of Coca-Cola, leaving plenty of room for foreign growth. PepsiCo's stock (symbol PEP), which closed September 15 at $65, trades at 22 estimated 2006 earnings. Schoenstein thinks PepsiCo has the stamina to sustain 10% to 12% annual growth. And that's regardless of the news.