Laundry detergent and toothpaste may not be razzle-dazzle products, but the companies that sell them tend to have healthy dividends and steady profit growth — making these consumer stocks worth considering if you’re a long-term investor.
Makers of consumer staples like soap, toothpaste or soda range from household-product giants like Procter & Gamble (PG) to food and beverage companies Coca-Cola (KO) and Mondelez (MDLZ), formerly called Kraft Foods.p>These days, most of their sales growth comes from developing markets, where household incomes are on the rise. And the companies tend to have solid balance sheets and growing dividends — features that lured Warren Buffett and partners to offer $23 billion for ketchup and sauce maker H.J. Heinz (HNZ) in February.
While prices for many consumer stocks have surged, some money managers still see good opportunities in the sector.
Charles-Henri Hamker, co-manager of the Artisan International Fund (ARTIX), says companies with strong brands and exposure to emerging markets have plenty of long-term growth potential. Hamker is emphasizing consumer stocks in his portfolio, including brewer SABMiller (SBMRY), global food giant Nestle (NSRGY) and wine and spirits firm Pernod Ricard (PDRDY).
“These mega-brands have massive pricing power,” he says. “In an environment of low yields and low growth, the resilience of their growth has been proven and continues.”
Income: Stocks vs. bonds
These stocks also look attractive relative to bonds, according to some analysts. The S&P 500 consumer staples sector yields roughly 2.5%, topping the 2.1% yield on 10-year Treasury bonds. Bonds have fixed coupon payments that may not keep up with inflation, while consumer companies typically hike their dividends as earnings grow.
“It’s a defensive sector with inflation protection that bonds don’t offer,” says Robert Lee, manager of the Fidelity Select Consumer Staples Portfolio (FDFAX). “Investors who left stocks for bonds might want to consider that there’s a middle ground.”
After a 41% surge the last two years, though, consumer stocks don’t look cheap. The sector trades at 17.5 times estimated 2013 earnings — a 20% premium to the S&P 500 (.SPX), which has a P/E ratio of 14.5, according to S&P. A higher P/E wouldn’t be worrisome if consumer companies were growing faster than the market. But that’s not the case: Wall Street expects operating earnings for the consumer sector to grow an average 9.9% annually over the next five years, versus 10.6% for the S&P 500.
In addition, some analysts see better opportunities in energy, financial and tech stocks — sectors that all trade at discounts to the market and have lower P/Es relative to their growth rates.
Commodity costs pose another risk to the staples sector. Timber, oil and grains are significant costs for many of these companies, and higher prices for raw materials would put pressure on profits. Global consumer products companies often count on foreign growth to propel earnings, which could come under pressure if the dollar continues to rise.
One way to mitigate these risks is to invest over a period of weeks or months. Staying broadly diversified can also help. And you should see how these stocks fit within your broader portfolio, making sure you don’t take on too much risk. As always, these investment ideas are only suggestions from experts we spoke with; you should consult a financial adviser or do your own research before investing.
5 consumer ETFs and funds
One way to invest in the sector is through an ETF or mutual fund; both are more diversified than individual stocks, potentially reducing some investment risk.
One of the largest and lowest-cost ETFs in the space is the Consumer Staples Select Sector SPDR Fund (XLP). The $6.8 billion ETF holds 43 stocks in the S&P 500 consumer staples sector, including Coca-Cola, Wal-Mart (WMT) and other household names.
Morningstar analyst Robert Goldsborough calls it a “high quality portfolio” that could be a good “satellite holding” to a diversified portfolio. The ETF has an annual expense ratio of 0.18% and yields 2.3%.
The downside: Procter & Gamble, Coca-Cola and Philip Morris International (PM) account for a third of the ETF’s assets, and while all three are highly diversified global businesses, they could drag the ETF lower if they stumble.
The PowerShares Dynamic Consumer Staples ETF (PSL) holds about 60 U.S. consumer staple companies. Based on a proprietary index that uses price and earnings momentum, valuation and other factors to weight stocks, the ETF is more diversified than traditional rivals.
No stock accounts for more than 2.7% of its assets and it holds some smaller-cap names such as Tootsie Roll Industries (TR) and sweetener company Ingredion (INGR).
The downside: The ETF’s 0.65% expense ratio is above average, according to Morningstar. Its 1.5% yield is slightly lower than rival ETFs, and it’s a bit more volatile than the S&P 500 consumer staples sector, according to PowerShares.
Few active funds focus on consumer staples and even fewer have been on the market more than five years. Fidelity Select Consumer Staples Portfolio (FDFAX) is one of the handful with both a long history and respectable record: The fund returned an average 10% over the last five years, beating 53% of peers and it returned an average13% over the past decade, putting it in the top 5% of its class, according to Morningstar.
Fund manager Lee analyzes the geographic sales mix of companies and emphasizes those with exposure to emerging markets. He also likes businesses with “pricing power” like baby food and spirits — areas where brands can drive sales and consumers are less price-sensitive.
The downside: The fund’s 0.81% expense ratio is higher than consumer staple ETFs. The fund may lag its benchmark and generate lower after-tax returns than a passive ETF.
Sticking with U.S.-based companies isn’t the only way to go.
The iShares S&P Global Consumer Staples ETF (KXI) holds half its assets in U.S. firms and the rest in foreign companies such as Nestle, spirits company Diageo (DEO) and British American Tobacco (BTI). These are huge global brand companies with generally steady sales growth and cash flows, according to Goldsborough. The ETF yields 2.1% and has an annual expense ratio of 0.48%.
The downside: Foreign stocks may add currency risk to your portfolio. The expense ratio is more than twice that of the SPDR ETF and the yield is slightly lower.
Another foreign ETF to consider: a recent entry in the space, EGShares Emerging Markets Consumer (ECON). Launched in 2010, the $1 billion ETF holds 30 leading consumer stocks in emerging markets.
Top holdings include Brazil-based beverage maker Companhia de Bebidas das Americas (ABV), also known as AmBev, South African multimedia firm Naspers (NAPRF) and Wal-Mart de Mexico (WMMVY).
Almost all the sales of companies in the ETF come from emerging markets, according to the fund’s sponsor, making it a pure play on emerging market growth. About 20% of its assets are in Mexico, followed by Brazil and South Africa at 17% apiece — regions with economic growth above the global average.
The downside: The ETF yields less than 1% and its expense ratio is above average at 0.85%, according to Morningstar. It may be more volatile than ETFs holding U.S.-based stocks, and it poses currency risk.
Daren Fonda is Senior Writer and Investing Columnist with Fidelity Interactive Content Services, a provider of objective investing content on Fidelity.com. He does not own any of the securities mentioned in this article.