PepsiCo Inc (NASDAQ:PEP): Why Return On Capital Employed Is Important

This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between PepsiCo Inc (NASDAQ:PEP)’s return fundamentals and stock market performance.

Purchasing PepsiCo gives you an ownership stake in the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. Your return is tied to PEP’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. To understand PepsiCo’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.

See our latest analysis for PepsiCo

PepsiCo’s Return On Capital Employed

You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. We’ll look at PepsiCo’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. I have calculated PepsiCo’s ROCE for you below:

ROCE Calculation for PEP

Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)

Capital Employed = (Total Assets – Current Liabilities)

∴ ROCE = US$9.6b ÷ (US$73.6b – US$19.7b) = 18%

The calculation above shows that PEP’s earnings were 18% of capital employed. This shows PepsiCo provides a favourable return to capital holders, which beats the 15% ROCE that is typically considered to be a strong benchmark. As a result, if PEP is clever with their reinvestments or dividend payments, investors can grow their capital at an attractive rate over time.

NasdaqGS:PEP Last Perf October 26th 18
NasdaqGS:PEP Last Perf October 26th 18

Does this mean I should invest?

The encouraging ROCE is good news for PepsiCo investors if the company is able to maintain strong earnings and control their capital needs. But if this doesn’t occur, PEP’s ROCE may deteriorate, in which case your money is better invested elsewhere. Therefore, investors need to be confident in the trend of the inputs in the formula above, so that PepsiCo will continue the solid returns. If you go back three years, you’ll find that PEP’s ROCE has increased from 18%. Similarly, the movement in the earnings variable shows a jump from US$9.0b to US$9.6b whilst capital employed improved as well albeit by a relatively smaller amount, signifying ROCE increased as a result of a greater surge in earnings compared to the business’ use of capital.

Next Steps

PEP’s investors have enjoyed an upward trend in ROCE and it is above a benchmark that makes the company a potentially attractive stock that can achieve a solid return on investment. This makes the company an attractive place to put your money, but ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. If you don’t pay attention to these factors you cannot be sure if this trend will continue or if you are getting a good deal for the future returns you are paying for. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.

  1. Future Outlook: What are well-informed industry analysts predicting for PEP’s future growth? Take a look at our free research report of analyst consensus for PEP’s outlook.
  2. Valuation: What is PEP worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether PEP is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.