Common Sense Says Pepsi (PEP) is a Buy


Stop me if you have heard this one before: A large, high-profile company reported a beat on both the top and bottom lines this morning, and their stock is lower in premarket trading as I write this. And in case you were wondering, they also raised their forward guidance for the rest of the year. These things have always happened, but it seems to me that they have happened more frequently in the last few years than they did in the past.

Maybe that is just my view being distorted by inaccurate nostalgia that often comes with age, but it definitely feels that way. Anyway, the thing is, investors should be careful when looking at the reaction to PepsiCo’s (PEP) earnings, and try not to read too much into the market reaction.

The iconic beverage and snack company earned more per share than expected ($1.29 versus $1.23) on higher revenue than expected ($16.2 billion versus $15.6 billion). That represented sales growth of over nine percent, even after the company took a big hit from the Russian war in Ukraine and subsequent moves out of the aggressor country. Perhaps more importantly was the way they achieved all that: Organic revenue grew by 13.7% in the quarter, indicating that much of the overall sales growth was down to higher pricing rather than more units.

That matters because, as I said a few days ago, companies whose brands are strong enough to withstand price increases have a big advantage in an inflationary environment. People already pay a premium over store brand prices for Pepsi, Gatorade, or Quaker Oats, or whatever, and this suggests they will pay a bit more to keep buying these particular products. Obviously, that is good news for PepsiCo and other consumer brand companies going forward, but there is one thing that would probably derail it. Consumers are now flush with cash but if that changes, generic products at a ten or twenty percent discount to their brands will become a lot more attractive.

So, is this negative reaction to good earnings a warning to investors that the market thinks such a time is coming? Maybe. There is another, more likely explanation for this seemingly illogical move, and this is a time to apply Occam’s Razor. That is the rule that when confronted with multiple possible explanations for something, the simplest, most likely one is usually true, and is basically the philosophical and mathematic equivalent of “if it looks liker a duck…”

It could be that the “illogical” move in PEP this morning is due to worries about the financial health of consumers, or concerns about a looming recession, or for that matter, it could be the result of heavy selling by aliens who landed on Earth this morning just to short PEP. Far more likely than any of those, though, is that it is simply a product of recent price action in the stock:

PEP chart

As you can see, this normally staid, unexciting stock has had a fantastic but relatively volatile last twelve months, gaining around 23%, including a 13% gain over the last six weeks. That 13% is even more impressive when you consider that over the same time period, the S&P 500 is essentially flat, having gained only 1%.

When you look at the chart, it is pretty clear that the resilience of PepsiCo in the face of inflation came as no surprise to the market. Traders and investors had already priced in good Q1 results. That means what we are seeing this morning is essentially a “buy the rumor, sell the fact” pattern. In other words, the reaction to good earnings tells us nothing other than that traders went into the release long PEP. It is not a sign of impending doom or anything else, but it may be a sign that PEP is worth buying on any pullback.

The earnings and revenue beats tells you that PepsiCo is handling inflation better than anticipated. If you believe, as most do, that inflation will be the dominant economic theme for several years, buying a proven winner like PEP in that scenario makes perfect sense.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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