We launched DTA’s Income Builder Portfolio last month by buying a piece of one of the world’s largest biotechnology companies, and we followed that with purchases of a blue-chip industrial conglomerate and America’s No. 1 tobacco-products seller.

While Amgen (AMGN), 3M (MMM) and Altria (MO) produce household names such as Epogen, Post-it notes and Marlboro, respectively, the companies themselves are not mentioned often in the typical U.S. household.

I mean, when was the last time anybody said, “After I use this 3M tape to pack this Amgen product for shipping, I’m going to take an Altria break”?

PepsiCo (PEP) is a name brand unto itself, and I really appreciate that as an investor. So I was happy to help the IBP initiate a PEP position on Tuesday, Feb. 27.

I executed a market order for 9 shares at $111.11 apiece. Including the $4.95 brokerage commission, the total paid was $1,004.94. Because the cost of our Feb. 13 Altria transaction was $982.20, we stayed below the IBP’s $2,000 monthly limit.

PEP is about a lot more than soda, as I showed in my previous article. It’s also about Frito-Lay snack foods, Tropicana juice and many other products. Oh, and it’s also about taking care of shareholders’ income needs.

Ka-Ching!

Pepsi pays a quarterly dividend of .805 per share. Because this order was placed before the next ex-dividend date (March 1), the Income Builder Portfolio will receive $7.25 in “Divvy Dollars” on March 30.

That’s pretty sweet but it gets even sweeter, as the company already has announced a 15% increase starting with the June payout. The quarterly dividend will go to .9275, or $3.71 per year. At that amount, Tuesday’s purchase was made at the 3.3% yield mark – notably higher than the company’s 10-year average yield of 2.9%.

In accordance with the IBP Business Plan, all dividends received will be reinvested right back into the companies from whence they came – a no-cost process informally called “dripping.” Using a series of clicks within the brokerage account, I elected that option for the PEP position.

The $7.25 the IBP receives on March 30 will be used to buy a fraction of a share. If PepsiCo stays in the same range as the initial purchase price, it would add .065 shares.

Then, three months later, the Income Builder Portfolio would receive the new quarterly dividend of .9275 applied to the new share total of 9.065 – making the June payment $8.41. If PEP is still trading at about $111, that’s an additional .076 shares.

And that, my friends, is how the compounding power of Dividend Growth Investing works: The dividend rate keeps rising, which in turn keeps increasing the size of the position.

Valuation Station

Some analysts believe PepsiCo is an attractive buy right now, while some think it could be a little cheaper. Considering the aggregate of those opinions, as well as various available metrics, I’m calling PEP just about “fairly valued.”

Morningstar’s Fair Value Estimate for Pepsi is $123, making PEP a 4-star value (on a 1-to-5 scale). The company’s 19.5 forward P/E ratio is considerably lower than its 5-year average P/E of 23.2.

CFRA is calling Pepsi a Strong Buy, and they see potential price appreciation of about 13% over the next year.

Value Line gives PepsiCo a target price range of $130-150 (as circled in red below), meaning the company could appreciate some 35% in value over the next few years. The stock research outfit also assigned PEP a 1.13 “Relative P/E” (blue circle), indicating slight overvaluation compared to the 1,700 companies in Value Line’s analytical universe.

According to the FAST Graphs valuation tool, PEP is trading slightly higher than its historic levels. That’s true whether we’re talking about the P/E ratio (first graphic below) or price-to-free cash flow ratio (second graphic). In both cases, the end of the black line (representing current price) sits just above the blue line (normal valuation over time).

Wrapping Things Up

If it’s good enough for me to buy it with Daily Trade Alert’s money, it’s good enough for my own personal portfolio. PEP is my 12th-largest holding (of 46 total positions).

And it’s a little larger now than it was just a couple of weeks ago, as I added 20 shares on Feb. 14.

Obviously, I consider PEP to be a sound choice for a DGI portfolio. I am not a financial advisor, however, and I urge every investor to conduct his or her own due diligence.

DTA’s next buy for the Income Builder Portfolio will be in two weeks.

— Mike Nadel

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