Although there is no such thing as an investment without risk, many investors look for companies that are known for stable growth and strong dividends — the type of stock that will make it through a recession with minimal losses and continue to grow on the other side.
Although these may be difficult to come by in cyclical sectors like technology and real estate, there are plenty of gems that fit the bill in the consumer staples sector.
But how do you go about being a successful investor in consumer staples stocks?
What to Look for in a Consumer Staples Stock
When investing in any category, it’s important to keep in mind that stocks are not all created equal. As in any other sector, some consumer staples stocks will outperform others. As such, it’s important to do your research and make sure you’re making the right moves before investing in the sector.
Here’s what you should be looking for as you do your research:
1. A Strong History of Consistent Sales Growth
The best consumer staples stocks come with a proven history of sales growth. After all, if consumers need the products offered by the company, the company should see growth as the population of consumers grows.
To determine whether the stock you’re interested in is generating strong sales growth, look at the past four years of earnings reports issued by the company. This will provide you with a full view of sales growth. If sales declined in any year over the past four years, there’s a strong probability that the company is experiencing headwinds, and the stock may fall in the future.
On the other hand, if sales have consistently grown on a year-over-year basis over the past four years, there’s a strong probability that sales will continue in the right direction, suggesting that an investment in the stock will be a winning move.
2. A High Dividend Yield
Although the consumer staples sector isn’t known for the highest dividends on the stock market, many of the most successful companies in the space do pay dividends, and like any other sector, you will likely find a diamond or two in the rough with a bit of research.
The vast majority of stocks in the consumer staples category provide investors with a dividend yield of under 2%, but there are blue-chip companies like Kraft Heinz and General Mills that offer above-par dividend yields.
The reason to look for high dividend yields is simple. As an investor, you want to generate as much growth as humanly possible. High dividends assist in generating high levels of total growth across your investment portfolio.
3. A Proven Ability to Thrive in Tough Economic Conditions
One of the biggest benefits to investing in consumer staples is the fact that consumers will need these products even during tough economic conditions, ultimately dampening the blow the stock takes when economic conditions fall into question.
By their nature, consumer staples stocks should do relatively well during tough economic times. On the other hand, it’s the stock market, and nothing is perfectly predictable on Wall Street. Although investing isn’t the same as gambling, it is an attempt at predicting the future. Because nobody can see into the future, things won’t always go as planned.
That being said, it’s important to look into the history of any company you’re considering, particularly its track record during tough economic times. The most recent market crash caused by COVID-19 in February and March 2020 will provide a strong indication of what the stock is likely to do when the market takes a dive, which will happen from time to time. It would also be wise to look into the company’s performance from September 2008 through June 2009 as the Great Recession pulled the market down.
You’re likely to see declines during these times, but if the company saw less dramatic losses than the overall market during these market crashes and came out the other side more or less unscathed, its history provides a strong indication of future strength.
4. A Reasonable Valuation
Investing is all about making money. The goal on Wall Street is to buy stocks at low prices, giving you the opportunity to profit through the sale of the stock when prices rise. So, it’s important to make sure you don’t overpay when you enter into a position.
Successful investors use a suite of valuation metrics to determine whether the price of a stock represents an undervaluation, overvaluation, or fair market value. Some of the most common valuation metrics include:
- Price-to-Earnings Ratio (P/E Ratio). The P/E ratio compares the current price of a stock to the annual earnings per share generated by the company. If a company generated $1 per share in earnings over the past year and currently trades at a price of $10 per share, the P/E ratio of that stock is 10. Investors also look to the forward P/E ratio, which compares analyst expectations of earnings over the next year to the current share price, or the mixed P/E ratio, which compares the last two quarters of earnings per share plus the next two quarters of analyst expectations for earnings per share to the current share price. The average P/E ratio in the consumer staples sector was 28.27 as of December 31, 2020.
- Price-to-Book Ratio (P/B Ratio). The price-to-book ratio compares the current price of shares to the book value of all assets on the company’s balance sheet. For example, if the company has $100 million in assets and a market capitalization of $200 million, its P/B ratio is 2. The average P/B ratio in the consumer staples sector was 6.16 as of December 31, 2020.
- Price-to-Sales Ratio (P/S Ratio). Finally, the price-to-sales ratio compares the current price of the stock to the annual revenue generated by the company. As with the P/E ratio, the P/S ratio can be trailing (current price compared to the past year of sales), mixed (current share price compared to the past two quarters of sales and expectations for the next two quarters of sales), or forward-looking (price compared to analyst expectations of sales over the next year). The average P/S ratio in the consumer staples sector was 1.35 as of August 31, 2020.
To determine whether a stock is undervalued, overvalued, or trading with a fair valuation, investors compare the ratios above for the stock they are interested in to the average ratios for the sector. The higher these ratios are, the more expensive the stock is. So, investors look for lower P/E, P/B, and P/S ratios when looking for opportunities in the stock market.
How Much Should You Invest in Consumer Staples Stocks?
Historically, over the long run, consumer staples stocks have generally delivered better-than-average returns, lower levels of risk, and a predictability that adds to peace of mind when investing. Not to mention, when you invest in these stocks, as a consumer, you already have an intimate knowledge of what the company offers.
Why not just throw all of your figurative investing eggs into the consumer staples basket?
Risks of Investing 100% in Consumer Staples
For some people, going all-in on consumer staples may prove to be a comfortable, long-term strategy. For most, the old adage is true: Never put all of your eggs in one basket. Lack of diversity in a portfolio that consists of only consumer staples stocks opens you up to added risk in two ways.
- Sector-Wide Declines. The benefit to a properly diversified portfolio is that if a single stock or sector starts to take on large losses, your entire portfolio is not at risk. While a sector-wide decline is rare in the consumer staples sector, it does happen. Sector-wide losses generally take place in consumer staples stocks when economic conditions are poor and consumer confidence is down. When this happens, consumers stop spending as much money, causing declines in revenue for consumer staples companies, and leading to a sell-off that could be painful if all of your money is tied up in these stocks.
- Opportunity Cost. While the consumer staples sector is generally known for producing higher-than-average gains over the long run, there are opportunities in other sectors from time to time that have the potential to lead to larger gains than consumer staples. For example, the COVID-19 pandemic led to a flurry of investments in vaccine and treatment development. As such, stocks in the sector saw dramatic gains in value, leaving consumer staples in the dust. If all of your money is tied up in consumer staples, you’ll miss out on large opportunities like this, ultimately costing you money.
What Percentage of Your Portfolio Should be in Consumer Staples?
Recommending a precise percentage that should be allocated to consumer staples is difficult because there is no one-size-fits-all solution. Every investor has unique financial capabilities, goals, and levels of risk tolerance.
To decide how much of your money should be allocated to consumer staples stocks, there are a few factors to consider.
- Your Age. One of the most popular methods for determining asset allocation percentages in stocks and bonds is using your age. Roughly speaking, your age should represent the percentage of your portfolio that’s invested in bonds. For example, if you’re 45 years old, you should have about 45% of your investing dollars in bonds and around 55% of your portfolio in stocks. That means, in this case, the most you should have in consumer staples stocks is 55% of your money, even if you want all of the stocks in your portfolio to be concentrated in this sector.
- Your Appetite for Risk. The lower your appetite for risk is, the higher percentage of your stock investing dollars should be invested in consumer staples stocks. For example, if you have an extremely low appetite for risk, you could meet your goals by putting your entire stock allocation into consumer goods stocks. However, if you have an average appetite for risk, you’ll want to allocate a smaller percentage to consumer goods stocks and a larger percentage of your investing dollars to higher-risk stocks that come with higher potential rewards like the technology sector.
- Economic Conditions. When you revisit your portfolio every quarter, it’s a good time to reassess the state of both the United States and the global economy. Remember that consumer staples are reliant on economic growth. If economic conditions are poor, you might greatly reduce your exposure to consumer staples, as consumer spending is likely to decrease, leading to losses in these stocks. However, if economic conditions are positive or improving, you might consider increasing your exposure to the consumer staples sector to take advantage of a wave of increased consumer spending.
- Your Investing Style. Consumer staples stocks are generally best for buy-and-hold styles of investing. The stability and slow, steady growth seen with these stocks makes them perfect for long-term moves. On the other hand, if your strategy is focused on more active investing, where you look to buy and sell stocks daily, weekly, or even monthly, you aren’t likely to realize the gains you want to see over these short periods. This makes consumer staples stocks less appealing for an active strategy.
- Follow the Leaders. Another tactic is to follow the leaders in the investing space. For example, Warren Buffet, and his fund, Berkshire Hathaway, are heavy investors in consumer staples. To get an idea how to allocate your funds in the consumer staples direction, it’s a good idea to consider diving into their holdings. You can see a full list of Berkshire Hathaway holdings at CNBC. As the experts buy into or sell out of the consumer staples industry, it may be wise to follow them. After all, the analysts at Berkshire Hathaway and other popular funds live, eat, and breathe the stock market.
Investing in Consumer Staples Stocks as a Dividend Play
One of the most attractive aspects of consumer staples stocks is that the companies they represent are known to pay strong dividends. In fact, the dividend yield in these stocks often moves over the 3% mark, making the dividend income hard to ignore.
Nonetheless, if you are looking into consumer staples stocks as a dividend stock play, it’s important to pay close attention to the dividends declared by the company’s you’re interested in. No publicly traded company is required to pay dividends. Even in the consumer-staples sector, dividends will range wildly from stock to stock and can be subject to change or suspension if the company hits hard times.
So, take the time to get a good idea of the amount of dividends that you can expect. Dig into the dividend history and growth seen over the course of the last several years for any company you’re exploring. If its dividends are not growing alongside revenue and earnings, there are likely better options in the space to consider.
Also, never invest in a company without digging into key metrics. Although dividends may be great, investing in a company that isn’t likely to grow — even one with a strong dividend yield — will end up costing you in the long run. So, even if you’re primarily looking at consumer staples from a dividend standpoint, it’s important to invest only if you believe in what the company is doing and that its activities will lead to long-run growth in overall value.
Consider Consumer Staples ETFs
If you’re interested in consumer staples but aren’t interested in digging to find the best individual stocks and devoting the time to maintain a balanced portfolio, there’s another option. Exchange-traded funds (ETFs) have become overwhelmingly popular among the investing community. These funds accept investments from a wide range of investors and use the funds collected to invest in a diverse portfolio.
What’s more, there are tons of funds to choose from, many of which focus solely on consumer staples investments. Aside from saving you time on selecting your investments, ETFs can save you quite a bit of money in trading fees depending on your broker.
Consider Investing in Consumer Staples-Focused ETFs
If you’re new to investing or would rather take a relatively hands-off approach while exposing your investing portfolio to quality consumer staples stocks, consumer staples-focused exchange-traded funds (ETFs) are a compelling option.
These ETFs are bucket investments that invest their assets in consumer staples companies chosen for specific qualities. For example, here’s a quick rundown of the top three consumer staples ETFs on the market:
- Consumer Staples Select Sector SPDR Fund (XLP). The Consumer Staples Select Sector SPDR Fund is one of the most popular consumer staples focused ETFs on the market today. The fund is made up of a wide range of noncyclical consumer staples stocks designed to outperform overall markets should the market take a turn for the worse, while providing compelling returns in bull markets.
- Vanguard Consumer Staples Index Fund ETF (VDC). The Vanguard Consumer Staples Index Fund ETF is designed to provide investors exposure to the U.S. consumer staples market.
- iShares Global Consumer Staples ETF (KXI). The iShares Global Consumer Staples ETF is designed to provide exposure to the global consumer staples sector, not just that in the U.S. The ETF is relatively equally weighted between U.S. and global consumer staples stocks.
By investing in consumer staples-focused ETFs, you’ll gain exposure to the sector without having to make the tough decisions surrounding picking stocks one by one. Moreover, ETFs often lead to reductions in the overall cost of investing, as a single transaction fee covers exposure to a wide range of diversified stocks.
When investing in ETFs, pay close attention to the expense ratio. The higher the expense ratio on an ETF, the more you pay to own it. By keeping your fees low, you can increase your returns by tens or even hundreds of thousands of dollars over the life of your long-term investments.
The consumer staples sector is one where plenty of opportunities can be found. According to Nasdaq, these stocks make up a sizable portion of iconic investor Warren Buffett’s portfolio, and for good reason. They provide opportunities for both growth and stability among some of the most well-known companies in the world.
Nonetheless, as with any other investment, before risking your hard-earned dollars on any consumer staples stock, it’s important to do your research. After all, educated investing is generally the key to successful investing. By performing your due diligence, you have the ability to pick the stocks that will grow during positive economic times and provide stability during downturns. All in all, with a little research, consumer staples stocks can be big winners in your portfolio.