Reflections – Using a Multi-stage Dividend Growth Model to value PepsiCo (PEP)

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Expected Initial Growth (4 years)

  • Assume 7% average annual dividend growth for the first 4 years
    • PEP had average 6.75% annual dividend growth over last 10 years (from $1.65 to $3.17)
    • PEP had average 13.85% annual dividend growth over last 3 years (from $2.76 to $3.17)

Expected Terminal Growth

  • Assume 5% average annual dividend growth after the first 4 years
    • PEP had average 9.51% annual dividend growth over last 20 years (from $0.515 to $3.17)
    • PEP had average 8.32% annual dividend growth over last 10 years (from $1.425 to $3.17)

Required Rate of Return (assume to equal Discount Rate)

  • Am looking for a 12% average annual returns (over 10 years) on my investments
  • Assume 4% PEP stock price growth over next 10 years
    • PEP had average 4.38% annual stock price growth over last 10 years (from $71 to $109)
    • Relatively conservative considering that average stock price rose by 7.84% per annum over last 50years
  • This means I need an 8% annual dividend growth (12%-4%=8%) on the investment

Verdict

  • Current Stock Price: $109.92 (17/04/2018)
  • Valuation based on model: $111.368
  • UNDERVALUED

Sensitivity Analysis

  • 1% fall in Expected Initial Growth (4yrs) results in 3.53% fall in valuation
  • 1% fall in Expected Terminal Growth results in 22.85% fall in valuation
  • 1% fall in Discount Rate results in 51.05% rise in valuation
  • Highly sensitive to changes in Discount Rate
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