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 what are consumer staples stocks? And how do you go about being a successful investor in the sector?
What Are Consumer Staples Stocks?
Consumer staples stocks represent companies that manufacture and sell products sold under household name brands.
For example, Procter & Gamble is a consumer staples company that manufactures and sells health and hygiene products like Crest toothpaste and Luvs baby diapers. Even in times of tough economic conditions, Procter & Gamble and its investors will benefit from the fact that the average consumer isn’t willing to go without brushing their teeth and won’t let their child fester in a soiled diaper. Because it’s a consumer staples company, Procter & Gamble has an economic shield.
This shield Procter & Gamble has was on full display in 2020, when the COVID-19 pandemic rattled global markets. Although the stock dipped in February and March, the declines experienced were minimal compared to overall markets. Moreover, the stock recovered quickly, ending the year 2020 with gains of about 13.5% during a year when the Dow Jones Industrial Average generated a return of 9.7%.
Other consumer staples stocks are cyclical, meaning that they react to the cycles of the economy. For example, Coca-Cola is a consumer staples stock that produces and sells nonalcoholic beverages. However, the company saw tremendous declines as a result of the COVID-19 pandemic as consumers were unable to eat out at restaurants — a significant portion of the soft drink business — and opted for lower-cost drinks at home such as water.
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Breaking a Common Misconception
There is a common misconception that consumer staples provide protection from economic declines. However, that’s not always the case. Consumer staples are made up of both consumer necessities and consumer discretionaries.
Although consumer necessities are noncyclical — think toothpaste, soap, and cleaning supplies — by contrast, consumer discretionaries like soft drinks and luxury clothing are highly cyclical and will generally experience heavy declines during tough economic conditions.
Subcategories of the Consumer Staples Sector
As with any other sector of the stock market, the consumer staples sector is made up of multiple smaller subcategories. These subcategories include:
In order to access the products they need, consumers shop at a wide range of retailers. These retailers are considered consumer staples because they are the go-to outlets for the products that consumers use in their day-to-day lives.
Some of the most popular retailers in the consumer staples category include:
- Walmart (WMT). Walmart is one of the largest retailers in the world. While the company offers plenty of consumer discretionary products, it is also the home of necessary consumer staples products like food, cleaning supplies, and toilet paper.
- Costco Wholesale (COST). Costco is a wholesale club that provides discounts to consumers for buying food, toiletries, and other consumer goods in bulk. Like Walmart, the company offers a wide range of both necessary consumer staples and consumer discretionary products.
- Amazon.com (AMZN). Amazon.com was transformed into a consumer staples stock during the COVID-19 pandemic. Like others on this list, the company offers plenty of consumer discretionary products. However, when the COVID-19 pandemic caused stay-at-home orders, Amazon.com became an indispensable source of necessities for high-risk consumers that didn’t feel safe shopping in brick-and-mortar stores.
2. Food and Drink
Could you imagine life without something to eat or drink? It wouldn’t last very long. The companies that offer food and drink products are often strong performers in the consumer staples sector.
Some of the most popular include:
- General Mills (GIS). General Mills is most well known for its cereal brands, but the company is far from a one-trick pony. The company manufactures and distributes products under many popular brands, including Gold Medal Flour, Betty Crocker, and Yoplait.
- Coca-Cola (KO). Coca-Cola is one of the most well-known brands in the world. Known for its Coca-Cola brand soda, the company also has a long line of diversified products including Fanta and Sprite. However, the company’s core focus on the non-alcoholic beverages market didn’t bode well during COVID-19.
- PepsiCo (PEP). PepsiCo is another company known for its cola brand, Pepsi. However, the company operates in areas outside of non-alcoholic beverages. In fact, its food brands like Fritos, Lays, and Quaker helped the company maintain shareholder value, even in the face of the COVID-19 pandemic.
3. Beauty and Hygiene
While you won’t die if you don’t put on your makeup, many consumers view beauty products as a necessity. Furthermore, hygiene products like toothpaste, shampoo, and body wash will be in high demand, regardless of the state of the economy.
Some of the most popular stocks in the beauty and hygiene subcategory of the consumer staples sector include:
- Procter & Gamble (PG). Procter & Gamble is the company behind Crest toothpaste, Charmin toilet paper, and Tide laundry detergent. The company also offers a wide range of consumer staples products in the beauty category, such as Covergirl and Olay.
- Estee Lauder (EL). Estee Lauder is the company behind popular beauty brands such as Aveda, Aramis, and Clinique. Unlike Procter & Gamble, the company’s core focus is on beauty and hygiene products.
4. Adult Consumer Staples
Although most parents discourage their kids from picking up their first cigarette or alcoholic beverage, these products have become consumer staples in their own respect. There is a large percentage of the United States adult population that uses tobacco or alcohol regularly.
Some of the top stocks in this category include:
- Altria Group (MO). Altria Group is the largest tobacco company in the United States. The company owns Phillip Morris, the maker of Marlboro cigarettes, and U.S. Smokeless Tobacco.
- Ambev (ABEV). Ambev is an alcoholic beverage company. It’s the company behind brands like Skol, Brahma, and Presidente.
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.
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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.
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 investment 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.