Kraft Delivers The Goods

By Sham Gad | August 10, 2009 AAA

Last week, international food giant Kraft Foods (NYSE:KFT) reported quarterly results that corroborated with what many of us have been saying all along: consumers are adopting a more cost-conscientious lifestyle characterized by fewer nights dining out and more nights eating in.
Considering the subtle reaction in Kraft shares after the earnings report, investors didn't seem all that impressed that EPS from continuing operations in the 2009 second quarter were up 27% to 56 cents. To top it off, Kraft even revised full year guidance upward to "at least" $1.93 a share.

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Relatively Speaking
I'm not one to bank on expectations, but I'm willing to take Kraft's word that it will continue to sell its products to frugal consumers. And the company is successfully executing its three year turnaround plan - despite the 5.9% decline in revenues, operating income was up almost 8%.

On a relative basis, Kraft seems to offer the best value among major food companies. And Kraft's collection of brands - Digorno Pizza, Oreo cookies, Maxwell House Coffee and, of course, cheese - are some of the most recognizable and consumed products in the world. Yet Kraft trades at a P/E of 14 versus 15 for Kellogg (NYSE:K) and General Mills (NYSE:GIS), respectively. Even, Pepsico (NYSE:PEP), which has a sizeable food business, commands over 18 times earnings.

A Primer on Stock Valuation
If the above discrepancies don't seem meaningful, consider one that does: a dividend yield that is 30% higher than any of the above named businesses. This yield difference is substantial if you understand how stocks are valued.

Stocks are valued based the present value of the expected future cash flows. Only two options are available with those cash flows: reinvestment in the business or dividend distribution. Since the majority of those cash flows will occur years from now and not today, it stands to reason that the greatest value from holding stocks occurs after years of ownership. (For more, check out Stock-Picking Strategies: Value Investing.)

Kraft's Dividends
With Kraft, investors earn over 4% a year just from dividends. The company believes that earnings can grow by 7% to 10% over the next few years. If we assume that the stock price rises by the same 7% to 10%, then owners of Kraft can expect to earn 11% to 15% a year from the stock. The market rally of the past few months may have fooled investors into thinking that 30% to 40% annual returns are within reach for the masses.

Bottom Line
I think that in five years from now, if you have earned 11% to 15% a year, your performance will likely be better than most - and that includes professionals. One professional in particular, Warren Buffett, happens to be a very large shareholder in Kraft. If the stock is good enough for Berkshire Hathaway (NYSE:BRK-A, BRK-B), it's good enough for most. (For further reading, check out Warren Buffett: The Road To Riches and Think Like Warrent Buffett)

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