It's all about expectations. If you want a stock to go higher, you beat analysts' expectations. And if you want a stock to soar, you crush those expectations.
With earnings season kicking off Tuesday (a day that the market was mixed), it's time for a primer on how this all works to drive value creation -- value creation that I want you to cash in on. To make it digestible and understandable (if not plain old delectable), we're going to use the stock of PepsiCo (PEP) , because everyone knows it and because it was Tuesday's biggest winner in the S&P 500.
PepsiCo is a storied company, with Chairman and CEO Indra Nooyi serving as its current steward. Indra has done remarkable work turning a company that many thought couldn't survive the new era of health and wellness into a powerhouse of great tasting "good-for-you" and "better-for-you" options (with the latter two representing 50% of the fleet). That combination has consistently put PepsiCo at the top of the heap of consumer-packaged-goods enterprises.
I know that I was an initial skeptic. I can recall when I said on air that I had held a sleepover party for my daughter's swim team and they didn't even bother to eat the Doritos that I bought for the occasion. But it wasn't long afterward that I heard from the company, telling me about all of the new snack brands it had invented that would have been gobbled up because they were natural and better for you.
Well, it's been a decade now since that re-education, and I've been astonished at PepsiCo's innovation in not just snacks, but beverages -- and how much that's meant to the company's bottom line.
However, the whole consumer-packaged-goods group has been under pressure lately from multiple directions. The challenges range from a plethora of smaller, competitive players to escalating raw costs to Millennials' changing tastes and aversion to what we call the "center of the supermarket."
PEP remained above the fray for ages, delivering earnings beat after earnings beat that propelled the stock ever higher. Share prices have more than doubled since Indra took the helm, even as the rest of the group has pretty much stagnated unless they got takeover bids.
But lately, even PepsiCo has been a victim of this malaise, despite continuing to boost its dividend (it just took it up another 15%) and repurchasing stock -- a combination that's returning $7 billion to shareholders in 2018.
In fact, the company actually whiffed on a couple of quarters (pretty much unheard of), and you saw the stock plummet from $121 all the way down to $96. At that level, you got more than a 3% yield --unusual for a real growth company.
Now, when you have a record of accomplishment the likes of which is the idol of an industry but the idol suddenly seems in twilight, you begin to lose the love of the so-called analyst community. I say "so-called" because this noisy discordant group is anything but a community, unless jackals have suddenly figured out how to build a village replete with houses, a town square and a mayor. (Well, let's not be too harsh; these jackals certainly have more than their share of village idiots.)
But that's where our story really takes shape. Going into the quarter, PEP had rallied from $96 all the way back to $109. That's where some of these analysts decided to jump ship and start squawking about potential disappointments and shortfalls.
We began to hear whispers that Gatorade, one of PepsiCo's core products, had suddenly slipped badly. One troubled analyst even said not that long ago that a survey had showed that there would be continual challenges to the product, which he spelled "Gator-Aid." (Ha-ha-ha, that good ol' analyst humor.)
Then we got rumblings that raw costs had escalated. Aluminum tariffs were going to hit PepsiCo can costs hard. Escalating gasoline prices would slam the company, as would the rising wages of truck drivers needed to transport carbonated beverages to stores.
Then there's the renewed Coca-Cola (KO) , a pretty much dormant company that had gotten more creative and aggressive in taking shelf space and market share. KO and PEP had fought each other endlessly in the carbonated-drink aisle, a virtual Peloponnesian War that left both companies licking their wounds. But a truce of sorts had broken out in the last few years, allowing both companies to make more money than we thought.
However, that all ended last year when James Quincy took the helm at Coca-Cola and really went after PepsiCo, which was caught a bit flat-footed when the battle started up again. That gave KO -- or "Knock Out," as we call it -- a technical knockout of sorts and it looked like PEP was down for the count.
It didn't matter that PepsiCo said it would turn on the advertising jets and start to grow the business and take back share. The analysts had lost faith that the business could be reignited.
This negativity reached a crescendo in the past four days, when we heard the dreaded word "shortfall" and braced ourselves for PEP to return from $109 back down to the $96 level. Some of the best analysts really seemed to go out of their way to distance themselves for the stock, again with a clever twist. Like one wag who put out a piece saying: "We're not feeling so Bubly about PEP'S Q-2 fundamentals," using the same spelling as PepsiCo's new drink Bubly. Hardy-Har-har!
And then it happened. PepsiCo reported earnings Tuesday before the bell, and what did the company do? It crushed the numbers. PEP had 2.6% organic growth -- large for a packaged-goods company -- instead of the 2.2% analysts had expected. The company also earned $1.61 per share when the street was only looking for $1.53.
Now, numbers aren't always what they seem; sometimes there are one-time earnings, or a company might have benefited from an unforeseen tax break or favorable exchange rate. But this was a "Mr. Clean" beat -- simply a much better number than analysts had forecast.
How did it happen? First, PepsiCo's Frito-Lay unit shot the lights out. I'm talking about a 500-foot drive that broke the stadium lights as it soared out of the park.
The pastiche was incredible. Frito-Lay delivered 5% core growth, a number that you only get these days from the consumer-packaged-goods group's small, faster-growing players.
Gatorade? It didn't need any aid at all. The introduction of Gatorade Zero quickly produced astonishing results, as did the entire Zero-Sugar Gatorade portfolio.
How good? The incredibly non-promotional Indra exclaimed: "I hate to use the words 'flying off the shelves,' but its doing exceedingly well."
Oh, it doesn't stop there. Those raw costs? Easily eaten. The rivalry with Coca-Cola? Just like PepsiCo told us, it would up its spend on advertising and reclaim market share and growth.
Best of all, PepsiCo's stock had attracted a raft of short-sellers betting that they could cash in on an instant plummet - but instead, they heard the two most-dreaded words in the English language: "sequential improvement." Each month was better than the previous one for PEP.
In other words, analysts' numbers will now have to go higher given that the company's trajectory is getting better and better. Or, as you would like to see these jocular analysts write: "I bet you can't beat just one" -- as I think PepsiCo will now beat estimates for the rest of the year.
Indra has built a company to last, attracting the best and brightest to the packaged-food business with a commitment to sustainability and environmental progress. "Looking ahead, we will continue viewing our work through both a microscope and a telescope on the most granular detail -- grams of saturated fat, parts per billion of greenhouse gas, the number of women in management roles -- as well as the larger ambition of building a business that acts in accordance with our values, each of us striving to do what's right for the company and what is right for our communities. Because at the end of the day, there is no separating the two."
She's true to her word, except for doing what's right for the analyst community -- part of which is now in tatters after PepsiCo's blockbuster numbers.
When they have Great Expectations, that can produce a Dickensian tale of woe. But when analysts have lousy expectations and then get a quarter that produces a gigantic gain -- the biggest in seven years - that's worthy of "Congratulations, Indra, on a fabulous quarter."