Postcards: Why Is Pepsi Trading at 27 Times Earnings?

Great businesses are great investments... but fundamentals now finally matter in this market. Can we justify this investment? Can we justify any investment over 25x times earnings that isn't in tech?                                                                                                                                                                                                                                                                                                                                                                                                                 Forwarded this email? [Subscribe here]() for more [Postcards: Why Is Pepsi Trading at 27 Times Earnings?]( Great businesses are great investments... but fundamentals now finally matter in this market. Can we justify this investment? Can we justify any investment over 25x times earnings that isn't in tech? [Garrett {NAME}]( Oct 31   [READ IN APP](   Dear Fellow Expat: My daughter FINALLY got an opportunity to go trick-or-treating. She was sick with COVID two years ago, sick with the flu last year, and 2020 was a wash because of the Coronavirus shutdowns. We built this Halloween adventure up. We talked to her for a week about how AWESOME trick-or-treating can be. We discussed all the candy she’d get… and my wife and I were happy that, for once, she got to be a kid on Halloween. So… she put on her Elsa costume from Frozen. We got in the golf cart. We approached the first house… And the first person to ever give her a Halloween “treat” gave her… Top Ramen. Not even Maruchan Ramen. Top Ramen! I know that candy inflation was bad this year… but this can’t stand… I’m so confused. Still, I’ll probably eat that at 2 a.m. after a steady dose of Long Drink. [Upgrade to paid]( Compression Time I grew up in the boardroom of McCormick & Co. (MKC). I bartended at six years old for the executive team, played Gin Rummy against the sales team, and read the stock ticker of MKC on airplanes for my father. I love McCormick’s business model. They buy spices by the pound and sell by the ounce. But I struggle to justify that McCormick’s stock currently trades at 26 times earnings. Things are returning to normal in a world where fundamentals were discarded for 12 years. With interest rates moving higher - and likely to remain higher for longer - we must entertain the logic of “earnings compression.” I want to discuss this phenomenon today, as it will be a theme for the next two years. We’re currently in the middle of a paradigm shift… and it will be very hard for certain companies to justify their earnings multiples when interest rates sit at 5%. Valuation Compression Valuation compression refers to a situation where the prices of stocks or assets decline despite the companies' fundamentals remaining relatively stable. This typically occurs when investors become more risk-averse and less willing to pay high stock prices. As a result, price-to-earnings (P/E) ratios and other valuation metrics decrease. Various factors, like economic uncertainty, rising interest rates, or a shift in investor sentiment, can trigger valuation compression. Someone may look at a stock and say, “Listen - I love Pepsi as a company, but I’m not willing to pay 27 times earnings for this stock.” And suddenly, someone looks up and says, “I’m not willing to pay 26 times sales.” And another guy says, “I’m not paying 25 times earnings…” 24. 23… 22… And it just keeps falling… During such periods, investors may demand higher returns to compensate for increased perceived risk, causing stock prices to fall. This compression can affect entire sectors or markets, impacting overvalued and undervalued stocks. Investors must distinguish between temporary valuation compression and a more profound correction, which might indicate a broader market downturn. And I think that’s what we’re experiencing right now. Remember, most people under 40 have not experienced a stock market with interest rates above 4.5%. And I think it’s going to be really hard for the Fed to justify rates under 5% for the next 12 months. That will fuel the compression that I anticipate. While valuation compression can present buying opportunities for long-term investors, it also underscores the importance of assessing the underlying fundamentals of a company to determine its true value rather than relying solely on stock prices. The PE ratio of the S&P 500 is sitting just south of 24x. While the tech sector is now a bigger component of the index and may justify long-term growth, I have difficulty looking at a company like Pepsi or McCormick and justifying tech-style growth ratios for the foreseeable future. We’ll talk more this week about why I love energy, real estate, and a few other places to park money where I don’t see valuation compression as a threat. Stay positive, Garrett {NAME} Secretary of Defense You're currently a free subscriber to [Florida Republic Capital](. For the full experience, [upgrade your subscription.]( [Upgrade to paid](   [Like]( [Comment]( [Restack](   © 2023 Garrett {NAME} 548 Market Street PMB 72296, San Francisco, CA 94104 [Unsubscribe]() [Get the app]( writing]()