Stop Losing Your Shirt

It has been a wild ride for investors in 2008. We're flustered as economists debate whether the economy is headed for a recession, or if it's already in one.

Not that I totally believe economists really know what's happening. I'm firmly in the camp of skeptics who agree that astrology was invented so that economics could be classified as an accurate science. But I don't need precise statistics on the money supply to realize that so far in 2008, the Dow is down nearly 10% and the S&P 500 has tumbled more than 11%.

A defensive strategy
There isn't much hope for a quick turnaround, because our economy is in a pretty deep slump. However, my fellow writers at The Motley Fool recently suggested several interesting strategies to weather the storm, from selecting companies with big moats to buying high-dividend-yield stocks to simply not panicking. Sage advice all.

But I'll suggest that classics never go out of style, and one of the most classic approaches to conserving capital in a bear market is by investing in consumer product companies.

I'm the first to admit that toilet paper is not sexy, Q-tips aren't the next hot growth product, and toothpaste is less interactive than an iPhone. But our purpose here isn't to jump on a rocket headed for the moon. We're talking about conserving capital for a later time when the rocket is actually ready to launch. Consider this chart:

This group of giants is down 3.6% on average since the beginning of the year -- the Dow has dropped more than twice as much -- and three of the companies are nearly flat. On average, they pay a 2.1% dividend yield, which helps to lower their volatility. While their P/E ratios are a tad on the high side for a down market, they all have solid, long-term records of earnings growth, which in my mind justifies the slightly premium price.

These companies' large variety of products and strong international presence help to ward off single-product risk and foreign currency fluctuations.

Perhaps one of the best arguments for investing in consumer product companies is their cash flow. We all know the market tends to focus on profit-and-loss statements, and a host of related ratios like P/E and PEG ratios. But a company with strong cash flow has the strength to ride out tough times and the resources to make savvy investments when competitors may be just trying to pay their bills.

Procter & Gamble and Johnson & Johnson each delivered more than $10 billion in free cash flow in the past 12 months. Coke and Pepsi were around $4 billion, with Colgate-Palmolive clocking in at just more than $1 billion. But I think of cash flow as more of a theme than an absolute selection tool. Any company with annual free cash flow in 10 figures is raking it in.

Put the shoe on the other foot
One other possible way to play the "consumer staple in a choppy economy" theme is to consider retailers who make their living selling these products. There's an interesting kind of symbiotic relationship between manufacturers and retailers of consumer staples. They don't necessarily like each other, but retailers can't live without their suppliers, and vice versa. Each side does their best to make money, but they also have to make sure the other side stays reasonably healthy.

Wal-Mart (NYSE: WMT) shares have actually traded up so far this year, by 1.2%. The company reported decent same-store sales of 2.7% for December and may be finally getting its act together.

Costco (Nasdaq: COST) may be battered so far this year -- down 7% -- but its operations are still strong, as it beat most of the rest of the retail universe with 7% same-store sales growth in December. My readers know I consider Costco the best retailer on the planet, and I always favor this company on pullbacks.

For either manufacturers or retailers, the downside risk in consumer staple companies is less than it is for a lot of other sectors, and they have proven to be a smart investment when the bears are ruling the market. Stop losing your shirt, and sleep a little easier tonight knowing that you're invested in stuff people are going to buy -- no matter what.

For more on bear market strategies:

• The 3 Forces Behind a Market Crash
• Buy Quality on the Cheap
• You Can Profit Despite the Panic