(B)(N) PEP PepsiCo Incorporated

Drama. Coke and Pepsi turned in their good quarterly reports today, and there were no surprises and neither company has made any “bet the company” moves since 2010, and both of them seem to be effectively working on ways to maintain their franchise and further expand into foreign markets and different cultures (Reuters, April 18, 2013, PepsiCo first-quarter profit beats; stands by 2013 outlook).

Absent volatility (which we’ll talk about below), both companies have been in or eligible for the Perpetual Bond™ since early 2009 (please see Exhibit 1 and 2 below). The only requirement for a company to be in a Perpetual Bond™ is that the ambient stock prices as summarized by the Red Line Stock Price (SP) should be plausibly at, or above, or very near, to the Black Line Risk Price (SF) which is our best estimate of the “price of risk” based on the generally available and most recent quarterly balance sheets. Earnings and earnings forecasts are not factors in that calculation until they show up on the balance sheet, and, therefore, we don’t pay any attention to analysts’ reports, but a lot of attention to acquisitions, mergers, strategic initiatives, and marketing, product, or production gaffs that might corrupt their franchise, and, for any of these, we just check to make sure that our stop/loss or options are up-to-date.

In contrast, investors who do pay a lot of attention to earnings forecasts and “earnings surprise” are reduced to volatility players and reduced to reacting to the “news” which is news to them, and important to them, because they don’t know where they are. They don’t know whether the current stock prices are below, at, or above the price of risk, and their primary response to any news is a snap judgement to buy or sell before everybody else does, which is very interesting to those of us who do know where we are, and are, in contradistinction, the sellers or buyers (in that order); as a rule, we expect to be buying or holding what they’re selling or not buying; and selling, or not buying, what they’re buying. That’s why, for example, we can run a portfolio of six to twelve stocks in the Dow Transports that produced +28% in the first three months of this year, and will not produce less than that for the rest of year (please the references below).

Nor are we merely contrarian. The distinction that we make is between investors who are “risk averse” – we want to keep our money and obtain a plausibly hopeful rate of return above the rate of inflation – and investors who are “risk seeking” and best described as willing to gamble in order to obtain excess or “unearned” returns – “unearned” in the sense that they didn’t really know what they might be, or why they might have them, but they’re sure glad they did.

PepsiCo Incorporated is currently trading at $80 and is substantially above the Risk Price (SF) of $74 (please see Exhibit 1 below). The current dividend is $0.54 per share per quarter or $3.4 billion per year to its shareholders for a current yield of 2.6%. Our estimate of the downside in the stock price due to the demonstrated volatility is minus ($4) and we can afford to take that loss (however unlikely) because we bought the stock at $70 last July. Alternatively, the July put at $77.50 costs $1.17 today and the cost of that can be offset by selling or shorting the July call at $82.50 against our long position for $1.44, so that for a small gain of $0.27 per share ($1.17 less $1.44), we can be paid to do nothing for the next few months, and still be assured of our dividends and between $77.50 and $82.50 for our stock. (Other options, of course, are available.)

Exhibit 1: (B)(N) PEP PepsiCo Incorporated – Risk Price Chart

PepsiCo Incorporated is a global food, snack and beverage company, which manufactures or uses contract manufacturers, and markets and sells a variety of salty, convenient, sweet and grain-based snacks, carbonated and non-carbonated beverages and foods.

(Please Click on the Chart to make it larger if required.)

The CocaCola Company is currently trading at $42 and is also above the Risk Price (SF) of $37. The current dividend is $0.28 per share per quarter or $4.9 billion per year to its shareholders for a current yield of 2.6%. Our estimate of the downside due to the demonstrated volatility of the stock price is minus  ($2) per share and, again, we can afford to take that loss at $40 because we bought the stock at $37  in early 2012 (please see Exhibit 2 below). On other hand, the August put at $41 sells for $1.12 today and can be offset by a sold or short call at $42.50 that sells for $1.31 today, and so, again, we can be paid to do nothing for the next several months (if we so choose).

Exhibit 2: (B)(N) KO Coca-Cola Company – Risk Price Chart

The Coca-Cola Company is a manufacturer, distributor and marketer of nonalcoholic beverage concentrates and syrups.

(Please Click on the Chart to make it larger if required.)

The calculated Risk Price (SF) is a provably effective estimate of the “price of risk” which is “the least stock price at which the company is likeable” (Goetze 2009) and “likeability” is determined by the demonstrated factors of “risk aversion” – we want to keep our money and obtain a hopeful return above the rate of inflation.

Stock prices that are less than the price of risk are “bargain prices” but with the risk attached that the company might never get a higher price other than that due to ambient volatility or “surprise”. On the other hand, investors who are willing to pay the “full price” above the price of risk, and buy and hold the stock at those prices, must also be confident, and have reason to believe, that the company will produce those values, absent new information. Please see our Posts, The Price of Risk, August 2012 and The Nash Equilibrium & Its Stock Price, October 2012, for more details.

For more of our real investments in real companies in real time, please see our recent Posts, S&P TSX Winners & Losers, April 2013, The Dow Transports, March 2013, or The Wall Street Put, March 2013, or The Risk Adjusted Dow, March 2013, or The Canada Pension Bond, February 2013.

Postscript

We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

The Perpetual Bond™
“Alpha-smart with 100% Capital Safety and 100% Liquidity”
Guaranteed
With No Fees and No Loads on Capital

For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to RiskWerk@gmail.com.

Disclaimer

Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.