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Consumer Staples Portfolio Stock Screen Overview

Current Holdings
 

Average Annual Return of Trending Value Portfolio

We have created a stock screen that attempts to pick the best stocks from the sector with the highest historical annual returns (consumer staples). Not only has the consumer staples sector enjoyed the highest returns, it also has the second-lowest volatility. Only the utility sector has less volatility. In the Great Recession of 2008, the sector fell only 15.0% while the S&P 500 returned -36.8%. Return data from What Works on Wall Street, 4th edition, for 1967-2009.

Our stock screen attempts to find consumer staples stocks with solid balance sheets that provides financial stability. We also want companies with conservative accounting practices; we seek to eliminate companies with aggressive or suspicious accounting practices. And finally we seek to eliminate companies that have substandard growth in operating cash flows and earnings, as well as companies that have not met earnings expectations.

***

Background:

In their book What Works on Wall Street, 4th edition, authors Jim O'Shaughnessy and Patrick O'Shaugnessy researched sector returns and volatility over a 42-year period starting in 1967. This is what they found:

Sector Annual Returns Volatility
(Standard Deviation)
Consumer Staples 13.57% 15.76%
Financials 12.37% 17.74%
Telecom 11.86% 21.44%
Materials 11.59% 20.83%
Energy 11.57% 25.48%
Utilities 11.25% 13.69%
Health Care 10.55% 23.16%
Industrials 9.82% 20.55%
Consumer Discretionary 9.60% 21.97%
Information Technologies 7.29% 31.14%

Consumer staples stocks provide not only the highest return, but also the 2nd-lowest volatility. On the other end of the spectrum, technology companies provided the weakest return along with the highest volatility. Yet it's the tech sector that gets all the attention while the consumer staples sector is largely ignored. We can use that to our advantage, as we'll discuss later.

Consumer Staples: Which Companies Are They?

What kind of companies are in the consumer staples sector? They are companies in industries that provide goods and services that people have to buy, no matter the economic conditions. During recessions, do consumers suddenly stop buying food, toothpaste, beverages, and soap? No, they don't. Some examples of consumer staples are Coca-Cola, Proctor & Gamble, Kraft Heinze Co., General Mills, Kellogg Company, Campbell Soup Company, and Tyson Foods, Inc.

Advantages Of Consumer Staples Stocks

1) Highest Return of All Sectors

As we mentioned above, the historical return of consumer sector stocks is the highest of all sectors, coming in at 13.57% annually. That's 1.2% per year above the second-best sector and 6.28% per year better than tech stocks.

The S&P 500 originated in 1957. The number one performing stock in the original lineup of 500 stocks is a consumer staple stock, providing an annualized return of 20.2% (over one million percent). In fact, 11 of the top 20 long-term performers came from the consumer staples sector.

2) Low Volatility

Despite the high return, consumer staples are economically defensive. Only utility stocks have experienced a lower volatility, as you can see in the table above. As we mentioned in the introduction, during the Great Recession of 2008, the consumer staples sector fell only 15.0% while the S&P 500 returned -36.8%. The lower volatility makes it easier to stick to the strategy.

3) Wide Moats, Competitive Advantages, Barriers to Entry

Great investors like Warren Buffett and Charlie Munger state that a company with a good moat is one of the most important characteristics that they look for. A moat in the investing world is a company with some advantage(s) that keeps competitors at bay. These barriers to entry could be patents, a strong brand, regulatory licenses, economies of scale, cost advantage, switching costs, and the network effect. Many consumer staples companies have strong world-recognized brands that lead to historically high returns on equity. Three of Warren Buffett's best investments have been consumer staples stocks: Coca-Cola, Proctor & Gamble, Anheuser-Busch.

4) Strong, Iconic Brands Recognized Worldwide

Many consumer staples stocks have strong brands that are recognized around the world. Coca-Cola. Proctor & Gamble. Pepsi. Kraft Heinz Co. Hershey Co. Once a consumer settles on a favorite beverage like Pepsi or Coke, they are unlikely to change to an off-brand cola, even if it's much cheaper. This brand loyalty gives the company pricing power. And this leads to high returns on equity.

5) Persistently High Returns on Equity (ROE)

Over the past 50 years, consumer staples stocks have provided persistently high returns on equity (ROE). Usually, companies with high ROE and unusually high profits attract serious competition which brings the ROE back down to earth (reversion to the mean). But this hasn't happened in this sector. This is partly because of wide moats and strong brands. But it's also due to apathy. While many people are trying to come up with a great tech idea in hopes of being the next Google, Microsoft, or Apple, few people are trying to come up with a new toothpaste to compete against Crest or Colgate. There is also investor apathy, the next advantage.

6) Investor Apathy

Most investors aren't interested in investing in a company that sells soap or raises chickens. It just isn't "sexy." When people first get interested in investing, they usually want to shoot for the moon and find the next Microsoft or Apple. They have visions of being one of the first investors "in" on a stock, and they imagine themselves having the wisdom to somehow hold onto the stock through all the ups and downs, never giving into temptation to sell. Professional athletes are famous for making huge bets on extremely risky investments, with the majority of the investments becoming disasters. Remember, for every Microsoft, there are thousands of tech companies that failed completely. That's why the tech sector has the lowest return of all the sectors and the highest volatility.

But companies that sell toothpaste don't excite many investors, nor do they attract an inordinate amount of competitors that are vying to break into the toothpaste market. Less investors studying the sector and less competition in the sector means it's easier for us to find the hidden gems that are undervalued.

7) Easy to Understand the Business

Warren Buffett is also well known for only investing in companies that are easy to understand. Consumer staples companies are simple businesses that we consumers interact with every day. We don't need specialized knowledge like investors in biotech or pharmaceuticals. And because we are avoiding the "black box" businesses like Enron, we can avoid a lot of the companies that go bankrupt. That leads us to our next advantage: longevity.

8) Company Longevity

Because companies in the sector often have high returns on equity, they are less prone to bankruptcy. This also leads to the sector's low volatility. The result is companies produce stong brands with impressive longevity. Many date back to the 1800s. Their businesses don't change much and they keep chugging along, producing lots of free cash flow, which leads us to the next advantage.

9) Free Cash Flow, Consistent Dividends, Buybacks

Companies that continually generate high returns on capital also generate plenty of free cash flow. These cash cows can then use the cash to pay dividends and/or buy back stock. The latter increases shareholder ownership percentage. Our stock screen seeks to find consumer staples stocks that are particularly generous in boosting investor returns with one or both of these two methods. Most of the stocks have a long history of consistently paying dividends.

 

Current Holdings
 

 

Sources: Morningstar, What Works on Wall Street, investorfieldguide.com

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