Are These Drink Companies Over-priced?

Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Note: An earlier version of this article innacurately expressed Coca-Cola's relationship with its bottlers. The mistake has been corrected. 

If you're anything like me (and if you are, you have my empathy), you don't just want to find a great company to invest in. You also want to get the best possible deal. Now, I know that as I write this the stock market on the whole has been trading in a P/E ratio range of 17. But I don't like to make comparisons to how things are today. An example of how comparisons are annoying is that my savings account pays a crappy interest rate, whether you compare it to conditions in the early part of the century (around 5%) or to conditions in the mid-1990s (around 8%). I see today's sub-1% yields as pathetic because they lose buying power after inflation, not because conditions are or have been a certain way.

So I'm going to evaluate how good a deal a few companies in the drink business are based on the companies themselves, not based on how "the market" is valuing itself right now. I prefer to buy companies when I can get a good deal, not trade stocks based on technical indicators.

A Little Too Fizzy

For example, Coca-Cola (NYSE: KO) is trading at 19.71 times earnings, while Dr Pepper Snapple Group (NYSE: DPS) is trading at 15.57 times its earnings. Why are these pop-makers trading so high compared to what they're taking in?

On the one hand, it's hard for Coke to grow. Being a massive company, its days of doubling sales in a year are probably over with. But on the other hand, I can appreciate that Coke is hungry in spite of its age and extremely recognizable branding. It bought Inca Kola, which was out-selling Coke in Peru. It also bought Thums Up in India. In a reversal of strategy the past few years, Coke seems to bying up more of their bottler rather than merely selling them a concentrated syrup. Gaining more control over distribution offers advantages in cash flow and flexibility. Though, while I love Coke's stability and urge to improve its market share, I'd still hold off until it dips down into the 10-15 P/E range. There are other, better-priced fish in the sea.

I like how many brands Dr Pepper Snapple owns, which include my old favorites Yoo-hoo, Hawaiian Punch, and Canada Dry. I'm a little intimidated by Snapple because it has so many flavors -- it's just too much. But my phobia about too many choices doesn't change the fact that I like spin-offs (DPS came from Cadbury Schweppes in 2008) and I like companies with diversity that can balance that diversity with a solid focus in one area. But I don't really like the fact that DPS hasn't stood on its own for very long. Before Cadbury, Triarc owned the brands, and before that it was the Carlyle Group. I haven't seen enough evidence yet that Dr Pepper Snapple can stand the test of time and do more than coast on its laurels. Great brands are like sports cars in that they go fast and need a ton of maintenance to keep going.

Drunk on Success?

Brown Forman (NYSE: BF-B) came about because of a great idea: putting top-shelf whiskey in glass bottles. However, since that time the class B shares of Brown Forman have gotten into trading at 26.45 times earnings. I like the fact that Brown Forman is divesting its unrelated businesses like Lenox and Hartman Luggage and buying up internationally known brands like Chambord and Tequila Herradura. What I don't like about the class B shares is that they're non-voting, which basically means they're ownership rights that don't grant the benefit of having any control. You could pour money into this stock and still no more power over the Board of Directors than someone who bought a single share. As a guy who likes the voting process, I can't recommend that, especially not for 26 times earnings. With only a 1.6% dividend, what are people paying so much for? Good brands only count for so much.

A Bitter Aftertaste

I never had any idea how many brands Diageo (NYSE: DEO) owns. Having Johnnie Walker, Smirnoff, Baileys, Guinness, and being the only international distributor of Jose Cuervo, this is a company that pretty much owns the best of everything with alcohol in it. Coke looks like an underachiever with just one top-selling brand. But by the same token, Diageo trading at 24.23 times earnings looks a little off to me. Truth be told, while I love the branding I don't love the short-term thinking that has made the company shift around so much in recent years. Moving plants from Kilmarnock, Scotland to Leven, Fife and from Puerto Rico to the Virgin Islands to reduce its taxes seems a bit low. And threatening to withdraw funding from an award if another company won it (as Diageo ostensibly did in May of 2012 when Brewdog won Best Bar Operator) is very not cool.

While cost-cutting is always nice, every time I've seen a company become obsessed with saving money this means it's lost the fire to do the two things a company needs to focus on the most: producing a great product and getting it into the customers' hands. I don't feel like Diageo has that fire. So while I'd love to own a piece of some great brands, I'd only do so if I could get the company at a super steal (like a 5 P/E or so).

pongun has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Diageo plc (ADR) and The Coca-Cola Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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