4 Factors To Consider Before Investing In A Consumer Staples Company 1

When Jeremy Siegel and Jeremy Schwartz were doing research for the book The Future for Investors, they wanted to find the best performing stock from the original 1957 version of the S&P 500[i]. What they found wasn’t an exciting technology stock, or a behemoth oil company, but rather a simple consumer stock: cigarette maker Philip Morris (now called Altria Group). What’s more, Siegel and Schwartz found that 11 of the top 20 long-term performers came from the same boring economic sector: consumer staples.

And Jeremy Siegels findings were not an outlier. Consumer Staples companies – those that sell essential repeat everyday products such as food, beverages, tobacco and household items – have been found by many researchers to produce the best investor returns.

The main reason consumer staple stocks have historically outperformed is due to they exceptionally high returns on equity (ROE). What more, their ROE figured have been maintained over the years due to the consumer staple companies possessing very strong economic moats / competitive advantages in the form of brands.
But this is all changing as consumer preferences have shifted. For years it has been an undisputed fact of investment that people tend to prefer having big-name brands in their kitchens, bathrooms and elsewhere but this is not the case anymore. The increased private label penetration, particularly in developed markets, is hurting many companies in the consumer staples sector. Market share is being rapidly lost to these private label brands and operating margins are being eroded as a result. The majority of consumer staple stocks will not provide the same historic performance as they once did.

Investors now need to be selective when picking consumer staple companies. There will be a large divergence in returns between companies that are playing to the trend and those that are getting bitten by private labels.

When looking at consumer staple companies to invest in today, they are certain factors you need to take into account besides the obvious concerns; valuation and underlying financials (free cash flow, debt, operating margin, return on invested capital e.t.c). As an investor, you need to look for companies that have:

  1.  A portfolio of very strong brands that could be exploited using digital channels – c85% of Unilever’s portfolio, for instance, is comprised of brands that are number 1 or 2 in their category.
  2. A willingness to be flexible, adapt and invest consistently in the future.
  3. Exposure to categories where private label is less entrenched (consumer health, beauty, personal care, alcoholic beverages etc.).
  4. A well entrenched position in emerging markets.

The last point is of particular importance and it is a topic I will touch on again in more detail in the future. But in brief, emerging markets are the place to be as this is where the people and the growth are. Emerging markets is the reason why KraftHeinz attempted to takeover Unilever. But as an investor you need to take a patient approach. Emerging market economies have, on the whole, been through a difficult few years but structural trends for the consumer branded goods industry remain healthy. Per capita spend on these categories are still very low relative to developed markets (a fifth or less) whilst affordability and consumption trends remain positive. The potential from this long-term growth runway for companies such as Unilever, Diageo, Mondelez and PZ Cussons is substantial.

When looking at a prospective company to invest in, make sure the company you are about to invest in is on the right side of the above 4 trends. This is more important now than ever as the consumer landscape is changing whilst valuations placed on these companies don’t reflect that i.e. they are too high.