If you invested $10,000 in Kellogg (K +0.00%) 10 years ago, you'd have around $13,000 today. If you reinvested dividends along the way, you'd have closer to $18,000. But these returns lag the $30,000 you'd have had by simply investing in an S&P 500 index fund.
Despite this track record, investors may be tempted to think Kellogg stock can beat the market. Its products are in demand, its valuation looks low, and its dividend yield is above average. Yet each of these positive points has a valid counterpoint. In short, I'm doubtful Kellogg stock can beat the market.
But are there valid reasons to buy Kellogg stock anyway? Indeed there are, and indeed I did. First, however, let's look at the three points mentioned above.
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1. In-demand products in 2020
Kellogg is known for its breakfast cereals, but the company's products are far more diverse. In addition to cereal, it sells snacks, frozen goods, protein bars, vegetarian burgers -- a ton of consumer staples. And with the coronavirus pandemic, these products were in high demand. Consumers stopped dining out, and started gobbling up Kellogg products at home.
Organic sales are a measure of sales growth that excludes the positive or negative impact of acquisitions and divestitures. In the first half of 2020, organic net sales were up 8.6% for Kellogg. The company typically doesn't grow this fast. For example, organic net sales were flat in 2018 and only up 1.9% in 2019.
While accelerating revenue growth is positive, this isn't a reason to buy Kellogg stock now. The pandemic isn't driving the adoption of the company's products. Rather, consumers are necessarily changing behavior but will go back to normal once it's possible. So it's been a good 2020, but I don't believe it can be sustained.
2. Low valuation
With stocks near all-time highs, many investors fear they are too expensive. And to be sure, there are many stocks trading at historically high multiples. That's not the case with Kellogg. Judging the company by its price-to-earnings ratio, it's trading below its five-year average and as cheaply as it's traded all year.
Unfortunately, this doesn't mean Kellogg stock is necessarily an opportunistic buy. It partly grew its profit by deferring spending on marketing. In the early days of the pandemic, companies couldn't predict what would happen, so they cut their budgets. Kellogg did this by reducing in-store advertising and discounts, which boosted profitability when demand surged anyway.
The boosted profitability is temporary. The company merely deferred spending to the second half of 2020. It's already ramping its spend again, and its operating profit is expected to decrease. So as earnings decrease, its current valuation will increase and shares won't look as cheap as they look right now.
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3. An above-average dividend
According to data from YCharts, the dividend yield for the S&P 500 is currently 1.7%, near 10-year lows. By contrast, Kellogg's current dividend yield is twice as good at 3.45%. Over the long term, reinvested dividends add up, so having a high yield is important.
Kellogg is high yield, but its dividend growth is anemic. Over the last 10 years, the dividend has only gone up around 40% in total. In other words, what you get right now is about what you'll get in the future. There are better dividend stocks out there, some doubling their payouts in five years.
Image source: Getty Images.
So why buy?
I've just outlined some reasons why Kellogg could underperform the market, but here's why I bought shares anyway.
For starters, Kellogg is a low-volatility stock that has a place in a diversified portfolio. I certainly appreciated its stability when the market crashed earlier this year. From Jan. 1 to March 18, the S&P 500 was down 26%. By contrast, Kellogg stock was flat. Granted, it's missed out on the huge rally since then. But psychologically, it was nice to see at least one stock not plummeting; it reminded me to treat each stock in my portfolio on its own merits, not the macro trends.
Kellogg stock has stability and a consistent high-yield dividend. But that's true of many legacy consumer-goods companies. Why choose Kellogg stock over the alternatives? While it has been a low-growth company, it does hold a wild card that could reward shareholders with growth.
Incogmeato is a line of plant-based meat products that the company is launching this year. Competition includes Beyond Meat and Impossible Foods, two companies struggling to keep up with growing consumer demand. Given Kellogg's vast distribution network, it's plausible Incogmeato could quickly become a valuable brand.
I wouldn't buy Kellogg stock solely for Incogmeato. It's way too early. However, if you're looking for a stable stock like Kellogg anyway, Incogmeato provides growth potential many other legacy companies don't have.
