Top 5 Consumer Goods Companies for 2021

In this episode of Industry Focus: Consumer Goods, join host Emily Flippen and Motley Fool contributor Asit Sharma as they put their top five consumer goods companies for 2021 and beyond in their "shopping basket" and personal portfolios.

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This video was recorded on Jan. 19, 2021.

Emily Flippen: Welcome to Industry Focus. Today is Tuesday, Jan. 19, and I'm your host, Emily Flippen. Today, I am joined again by Asit Sharma as we look to build out our 2021 consumer goods stock basket. Asit, thanks for joining.

Asit Sharma: Emily, thanks for having me. I am really, really excited to be building a basket of stocks with you today.

Flippen: Yeah. I actually got this idea because as I was looking over my personal portfolio, I realized I own an embarrassingly few number of true consumer goods companies, despite having covered the industry for coming up on a year now. I thought we could steal a lesson, I should say, from the Jason Moser playbook, and actually put together a basket of our five highest conviction consumer goods businesses. I plan on buying shares of all of them. I think when we were talking preshow, you also planned on buying shares of all of them, at least for the ones that you don't already own. It'll be funded, check backend on these businesses next year and many years into the future.

Sharma: Yeah. Emily, the one thing that we have to do, today, we'll do the heavy lifting. We'll put together this basket. But after today, we have to brand the basket. Jason is so great. War on Cash. He's got so many nice names for his baskets. [laughs] We've got to come up with something catchy when we revisit this in a few months or later this year or in the years to follow. We have to put some really interesting intriguing name to it.

Flippen: I'm so bad at catchy names. It's part of the reason why I work in finance, which is an industry notorious for its lack of creativity. I'm so bad with that stuff, but I love it. I'm going to have to give this some thought about what we should name this basket. But we did have a couple of unwritten, I'll say, rules when picking these five companies. I did want to eliminate all pure e-commerce plays off the bat, because it almost felt like cheating. They were just too easy. There are so many great consumer goods companies that are just purely online and we've spent so much time talking about them. I own a large number of them already, and it's up for debate whether or not these are really consumer goods businesses. For the ease of simplicity, we just ax them. No pure e-commerce plays. No companies that I already own, mostly because I just wanted to focus on ideas that I hadn't really talked about, especially on the show before, and only picking what I'm calling true consumer goods businesses. When we put these together, we asked ourselves, if Dylan Lewis could do a Friday tech Industry Focus episode over the business, then maybe it's not consumer goods is enough with the intent of really nailing down five true consumer goods companies that we think could be great investments.

Sharma: Emily, I will say that I bent the rules on one pick, but I have an out for that. One of these stocks I own, but I bought it as a dividend play last year. I realized for this basket, hey, this is more than a dividend play. This is more than an income stream. We'll get to that. Other than that, I think I pretty much followed all the rules we laid out. [laughs]

Flippen: [laughs] That sounds good then. I want to dive into our five stocks. Before we do so, I want to let all of our listeners know that I apologize in advance for my raspy voice. My throat's a little sore at the moment, so I'm going to be letting Asit do a lot of the talking on these five companies. Hopefully you can bear with us for the rest of this episode. With that being said, Asit, do you want to dive into our first pick, which I really should say, your first pick, because you are the genius. You came up with this one.

Sharma: You're setting me up for a fall calling that a genius move. All my moves I think will be genius moves turn out to not be so. This is Sleep Number (SNBR -4.38%), SNBR is the symbol. We talked about this on a recent Industry Focus podcast, so I'm not going to go very, very in depth on this, Emily. This was actually, I think our first podcast of the year. Wherever you get our podcasts, you can take a look at, I think, our last show. You get a really detailed view of why I like the company and some great questions from Emily. To summarize, this is a business that's up 15% this year. It was up, I think around 70%, 80% last year. I've forgotten from last week. But it had a monster ride for what's essentially a mattress business. Sleep Number is unique in the mattress industry because it offers an adjustable smart mattress. They call it their 360 mattress. It is really tech-enabled. They sell these mattresses at a premium price point. The average is $4,800 per mattress. During COVID, their phone and e-commerce sales doubled to 14% of total sales. This provided a really large margin boost, which stripped their financials bare and showed that, well, this company is operating beyond the breakeven point, and if they could just lift their higher margin sales a little bit, most of that money is falling through to the bottom line.

Shareholders recognized that, last year they said the company did extremely well. But one thing I like about Sleep Number is that even though it gained strength in phone and e-commerce sales, they're going to keep building their store base out at a really fast compounded annual growth rate of 5%. When you have a base of 600-odd stores, these aren't small stores. That is not easy to do, but it's a great capital investment. I think it will be ultimately a nice equation for growth. Emily, one thing I didn't emphasize enough in our last podcast, Sleep Number is working to monetize the data it's been collecting over the years. They introduced their 360 smart mattress just a few years ago. They actually bought this technology and integrated it into their mattresses. They have an R&D office in Silicon Valley where they continue to work on the sensors embedded in the mattress and the data that they can collect. One billion sleep sessions that they've collected, they release that to customers nightly through an app that's integrated with the bed and you get a monthly sleep report. They started out with some pretty basic types of measurements like the amount that you move during the night if you get up to go to the bathroom, etc. But they're getting more and more sophisticated. In August, they introduced a night time heart variability metric, which shows how much your heart rate is fluctuating during the night.

They have this really big consumer sleep study that they have ongoing out in the real world with the Mayo Clinic. The CEO said on the last conference call that Sleep Number really wants to convert all of this data and the products of the research into services that they can sell. I see this maybe ending up as, well, actually something that a listener asked after we finished recording the podcast and we took questions on Live which we're recording today live. One of our listeners asked, "Well, couldn't this be a great subscription service?" That really stuck in my head. [laughs] I went back, did some digging around. I think, yeah, the data that they are collecting would be ideal for a premium layer to the already free data you get each day and every month. Also, they could sell some high tech accessories, which is more like some of the newer entrants into this industry. But I wanted to add this information for anyone who's interested in the stock. I think they've got a lot of growth potential, and I think they've got a very intriguing tech edge that could result in some multiple expansion in the coming years.

Flippen: Yeah. You and the listeners sold me on this one when you talked about it earlier this year. I don't think I realized just how tech-enabled Sleep Number is. After we taped that episode, it led to a really interesting debate with my boyfriend, Eric, about whether or not Sleep Number was a total scam in what they sell or completely genius. I love the fact they're selling at premium price points. Then they could potentially even get into something that's subscription-based or tech-enabled in the future. That optionality reminds me of another company that we have on this list that we'll get to in a minute. But I like companies that foster that sense of debate. We don't see it often in the consumer goods industry. That to me says that, sure, could it not work for Sleep Number? Of course. But if it does work, it's really revolutionary.

When you think about the fact that people spend to a third of their lives in bed asleep, you can see how Sleep Number would make a really interesting argument that people should be paying for something like a premium mattress and then maybe even a subscription or some app on top of that that really keeps you up-to-date with your ease and ability of sleep, especially given the amount of money that is going into sleep treatments. Medication, sleep apnea, all these different things. So, I like it. I'm excited to be adding this one to my personal portfolio whenever I'm able to do so, of course. But I probably would say it's the most controversial stock we have on the list, but I think it's probably one that would take a little bit more pushing for a lot of our listeners to buy into based off some preconceived notions they may have about the mattress industry.

Sharma: True. Emily, you have your first choice up. I'm going to go over your basic outline and then ask you some questions. Maybe just do a global comment on this. But you picked a company that's caught my eye as well. Grocery Outlet (GO 0.11%), symbol GO. This is a retailer and you told me that this is like the Ollie's of groceries. For anyone who's ever had a visit to an Ollie's in your city, Ollie's is a really fun discount jack of all trades in the retail industry. They have what to me is like a treasure hunt experience. You walk in, there is always something new. We have one near where I live. But you also mentioned that, while this is a grocery store that has that element, it's different from other discount retailers and other grocery businesses. The reason is, they don't have company-owned stores, but they also are not franchises, of course[laughs]. They have independent contractors. They call them independent operators or IO, and you pointed out that this is the same legal structure that Uber and Lyft use to run their businesses. The IOs open the stores, and Grocery Outlet then sells discounted items from their suppliers to the IOs.

This is so interesting because in the gig economy, we think of independent contractors as really small tradespeople. But here's basically a business built around this concept, which is interesting. I'm trying to think of another company that has the structure and I cannot think of one that's quite like it. So the IOs, they take complete control over their own stores, can make decisions within the stores including hiring, pricing, and supplying. Now, Grocery Outlet, also like Ollie's, they buy overstocked name-brand grocery products from suppliers at steep discounts. While they're out there buying stuff, really at a discount, and then selling it to their IOs, for the most part, and at this point in their business model, these aren't off-brands or private label brands. They're buying brands that you would recognize when you walk into the grocery store. The IOs take control of the inventory at the time of purchase. This is important. They then have a lot of control over what they're going to purchase or not. It's not that they have these agreements.

I'm trying to think of a company which might be an example of this. Okay, so Domino's, we've talked about Domino's Pizza. They have ongoing agreements with their franchisees, so they are supplying dough and vegetables for the pizzas. You have to keep buying those if you're the franchisee. Here with Grocery Outlet, it's a transaction-by-transaction basis. Once that inventory is offered, they can buy or pass, they could take control of it. Then the IOs sell these products at a discount rate of 40%-70% off typical brand prices in other grocery stores. Reminds me a little bit of Lidl, the German grocer, which has come into a lot of metropolitan areas, in that many of their brands are discounted steeply 30%, 40%. The difference is Lidl is always trying to mimic packaging [laughs]. They've got their version of Oreos. It looks like Oreos until you pay attention. This is different though, because Grocery Outlet's independent operators, as I said, they're buying name brand stuff and you're getting that at a 40%-70% discount. You can see how attractive this is from the consumers' point-of-view. I guess the selling proposition or the value proposition here is that the IOs have the best idea about what types of products will sell, where they are located. They're on the ground. They know their markets, and it's a win-win situation in that sense. Maybe I will turn it over to you to walk through the revenue model and I'll ask you some questions.

Flippen: Yeah, this is one where you shouldn't give me credit here, because you actually sent me a list of companies that you thought could be good candidates for this basket and Grocery Outlet, the ticker GO for those who are unfamiliar with it, was on that list. I was one of the people who was unfamiliar with this company until I started to dig more. The revenue models really just surprised me, and the structure itself surprised me with the IOs. There are true independent contractors, I think, as the law intended when setting up the opportunity for independent contractors. But the interesting thing about their revenue model is that they actually, the way they make a majority of their money is by sharing gross profit with the IOs at the store level, so that independent operators get to keep 50% of the gross profit of the store. The other 50% goes to Grocery Outlet. They're really incentivized to keep their costs low, to understand their consumer, and only order the products that they think are going to sell out in their specific locations.

This has turned into a really, really stable business model. I'm amazed by some of the numbers that Grocery Outlet has been able to put up. They have gross margins that have historically, even during the pandemic, ranged between 30.1%-30.8% since 2010. That's a decade of gross margins that are really strong and really, more importantly, predictable. It's a really stable business. Additionally, by sharing at the gross profit level, they're actually getting a bigger cut as a business than they would be if they were sharing, I would say, the net income level. Because they're taking up things like marketing costs, which they don't have to pay from corporate headquarters. Then additionally, all of this predictability and stability has led to 16 consecutive years of growth in comparables in store sales, which is absolutely amazing for a retail company. Now, a lot of this has probably been helped by the fact that they only have a 75-day cancellation period. So either party, that's independent contractors or the IOs and Grocery Outlet corporate can cancel the contract that they have with independent operators to run those stores within any 75 days. Stores that are under-performing presumably get cut much quicker than they do if their company-owned stores or franchise-owned stores. But either way, being able to have that flexibility has ensured that only the most profitable stores stay open.

Sharma: I love that point that you just made, because a lot of times you'll see when you're just reading through numbers of a company that you like, the comp sales are moving up, and that's just through really great hard work. Maybe traffic is increasing. But this idea that the company has maybe an easier way to call under-performing stores, it's something. As you say, maybe that's one of the reasons why it's been able to show this comparable sales growth. But it takes a good management team to say, "You know what? We've given this IO six months or a year, or two years, it's time to cut that umbilical cord. Maybe they can go out and brand themselves, but they're not going to be part of our structure," and that's led to some success. I just wanted to point out really quickly, just scanning their last earnings report, for a company which has recently IPO'd, they had pretty nice-looking numbers beforehand.

If you look at basically the nine months that ended at the end of September of 2019, they had a teeny-tiny net income of about $5.6 million on net sales of about $1.9 billion. That's actually not bad for a grocery business. But they have definitely ramped up during COVID, and this same period that ended at the end of September 2020, they had net sales of about $2.3 billion and $82 million in net income. I guess the hope is that they'll be able to retain some of that going forward. But it's not the question with so many other retailers we're looking at. How much of those profits will they be able to retain? Of course, comparable sales are through the roof during the pandemic. That's going to slow a little bit.

Flippen: Of course. One of the things I do like about this investment opportunity though is just how few Grocery Outlet stores there are. I would imagine that a lot of our listeners may have never seen or heard of Grocery Outlet before listening to this episode. There's only 350-ish stores across the United States. But management believes there's a long-term opportunity to get that number closer to 1,500 stores, and they're opening pretty aggressively, which makes me excited about the growth opportunities here. Because again, in the consumer goods space, we don't always have a ton of growth opportunities. But that being said, there are risks. For me, the two biggest risks were one, their debt load. This is a pretty heavily indebted company. Now, they've been able to service that debt again, because it's a really predictable business, and interest rates being as low as they are, it's easy to understand why it's heavily indebted, but that's always a risk with businesses. But the other one to me is this growth of private-label brands. You mentioned Lidl as an example, Aldi could also be an example. Even Costco's, goes right? All of Targets. These businesses are trying to get consumers to buy their own private label as opposed to name brand items. To the extent that consumers feel comfortable buying those alternatives at cheaper prices, there may not be the catalyst to go visit a grocery outlet to get the name brand Oreos or whatever else you're looking at for a cheaper price if you're totally fine buying the Lidl off-brand.

Sharma: I think that's a risk going forward. This is so interesting, Emily, because what you said at the outset, actually, right before we start talking about Grocery Outlet, the thing about having a controversial metric or controversial big-picture view of a company, to me, you're absolutely right. That shows that there's some potential there. If you can argue about it, it means that you're really looking at something which has the potential to grow. I think that given these risks, I also am taken by the company's business model and its opportunities. It does remind me of Ollie's, because Ollie's is doing the same thing. Ollie's has a relatively small store base, it's got a lot of white space out in many regions of the U.S. So, these small concepts, over time, can really return a lot of capital in terms of just growing margins and eventually, getting more resources on the balance sheet and lightening the debt load some while continuing to produce a lot of profits and cash flow. So yeah, let's both purchase Grocery Outlet, symbol GO, [laughs] and see how it does. Go ahead.

Flippen: The next company that we have here on this list, again, I'm realizing as we go through this that I managed to pick some edgier consumer goods companies here, and this may be the edgiest of them all, because of its checkered past with investors. But that's Beyond Meat (BYND -0.58%), ticker is BYND. But I expect a lot of our listeners are probably already familiar with this business. I'm curious, Asit, because I put them on the list without [laughs] consulting you. This wasn't one that we really chatted about before I put it on the list. Do you like Beyond Meat? By me adding this to the list, am I forcing you to buy shares of Beyond Meat?

Sharma: No, you're not, actually, Emily. I hesitated after Beyond Meat went public because as listeners, peers will remember, it just soared out of the gate. So, it was hard to buy, even though the proposition was really enormous, that this is a pioneer in the alternative meat category with Impossible Foods. I think those are the two biggest brands out there in terms of buying share for consumers. I wrote about Beyond Meat earlier last year during the pandemic, because I really admired one thing that they did, they had a period where everything just shut down. All of their inventory that was going to go into food service institutions, fast food restaurants, etc., they actually spent several million bucks to repackage that and to get it into grocery stores at promotional prices. There was a signal that just went off. I remember as I was writing this article, looking at the numbers and thinking, this is a sign of a very sharp and aggressive management team. They turned on a dime, they took some risks, but they increased their mind share with consumers. So, I have started to admire Beyond Meat. I noticed it was only up 66% [laughs] last year. [laughs] There's many stocks that I liked that were up, they doubled or maybe, they were up 250%. A company that has this kind of long-term potential, maybe this is the opportunity that I needed, this is the permission I needed to buy the stock, but I'll let you explain some more globally about it, and we'll pick this proposition up a little bit more.

Flippen: It's Interesting to me that you highlighted their 66% year-to-date returns, I guess for 2020, maybe not 2021 quite yet, as being somewhat maybe muted in comparison to a lot of these other highfliers. I think a lot of investors may feel slightly differently depending on if and when they bought during 2020. Because while it had an amazing run-up for the first half of 2020, in the second half, the realities of the pandemic started to set in and I think at some point, lost something like 20%-30% of its value on earnings, because they're a food service revenue which is the revenue that's derived from restaurants selling their products was down substantially as a result of people obviously not visiting restaurants. That hasn't really come back quite yet, and I think that makes a lot of investors nervous, but I'm really excited. I agree with you, I think that where the price of oil is today, in comparison to the market opportunity for meat alternative products, can make Beyond Meat maybe one of the better long-term buys that we have on this list in terms of growth opportunities.

One-in-five Americans identify themselves right now as a flexitarian. If you look at Chipotle sales, and I love comparing it to Chipotle, Chipotle has consistently sold around 12% non-meat meals, meaning people will come in and opt to not get meat, either they're Sofritas or the veggie with guac, whatever it may be. There's a large and increasing number of at least Americans, and this does expand to some countries internationally as well, that are looking to make their lifestyle more plant-based. Not to cut out meat entirely, but to consume more meat alternatives. This is the market that Beyond Meat really plays in.

The No. 1 question I think we have about Beyond Meat is about competition. What makes Beyond Meat special? There are so many different types of meat alternative products. I mean, besides the fact that their CEO and Co-Founder has spent his entire life devoted to this formula, I think what sets them apart are their agreements and their distribution. They're obviously in retail stores, have the locations right there in the meat aisle, which has been shown that people will pay a premium to get that fresh meat looking product as opposed to going to the freezer aisle, but more importantly, they keep winning deals with casual and fast food restaurants. The most recent one is Taco Bell. They're partnering with Taco Bell to develop a plant-based product. That's really notable. I think the stock was up something like 15% last week on the news of this. It's because Taco Bell was actually talking to many different companies about developing this product, including Impossible Foods. So, the fact that Beyond Meat came out ahead I think shows some sort of growing brand loyalty that maybe the management at Taco Bell wanted to tap into. I'm really excited about their opportunities and I'll move on in a second, because I realize I'm talking about this company quite a bit. But I really want to also mention their international opportunities. Beyond Meat has a former Yum China executive working on their outreach and distribution in Asia. They've already made really impressive inroads into China, I would expect them to continue to do that internationally, which really, to me, just says the market opportunity here is a [...].

Sharma: Yeah, Emily. If I'm not mistaken, if I remember this correctly, they're actually investing in manufacturing capacity in China. So the distribution plus just getting manufacturing on the ground there, it's an important market and again, sign of an aggressive management team. Moving into China pretty early in the game, even though they caught some flak for that at the very beginning because many analysts pointed out that the Chinese really, at this point, they love meat, they love their pork. You've lived in China, so you can probably attest [laughs] to this personally. I think that was a really great move and I think, really, with an emerging middle-class around the globe, people are looking for meat alternatives, whether that's your personal preference or not. So, smart move, great company with a lot of potential, I will happily buy this once our disclosure periods, and we can safely buy these stocks. [laughs]

Flippen: I'm looking forward to our next company as well, because up there with Beyond Meat, this is a company that I threw on there maybe without consulting you as much as I should have. If Aaron Bush knew that this company was breaking my top five, I think he would feel very, very proud and maybe a little bit scared that I have changed my tune so quickly on this business. But I have recently, as many of our listeners are aware, gotten myself a NordicTrack bike, and I feel like my exposure to the home fitness industry as a result of this purchase has made me a lot more keen on this investment opportunity, which in case you haven't figured it out already, is in fact Peloton.

Sharma: So, Emily, symbol PTO. I must say that you have been very vocal, I think, in your skepticism of this ticker, [laughs] so I am surprised by this. I will challenge you here because I think this is an amazing brand so far and they have really captured the imagination of so many of us during the pandemic. I don't own a NordicTrack or a Peloton, just full disclosure. But for me the magic is going to be in that continued pull of consumers, it's going to be in the branding. I can't help but feel scared that this could be a commodity product. Let me give some of your rationale here and then we'll talk. One of the things that really hits you was the company's 90% 12-month retention rate with a churn of only 0.6%, just over a half of percent for subscribers.

That speaks to that brand loyalty that once you buy the Peloton and you subscribe to the service, you're in it. You are going to get, not just your money's worth, you're going to make your body feel good. You are going to get back on that bike, be there for the instructor that you like. It's an experience, something that you quickly get attuned to as a consumer. I think this metric, which is great to look at, it's higher than one would expect for such a company, because there is a lot of competition in the space there. Any number of bikes, we've looked briefly at one, but as I mentioned, when we talk about sip numbers in our previous podcast episode, that's probably the first purchase we'll make. We really can get some exercise bikes too. If you punt down the money for a Peloton, I think part of it also is just prestige and the sense that you have bought into this great product, let me now get all I can out of it. You like that they are expanding their product suite, so they've got a backlog for their bikes and treadmills that is months long and they're looking at getting into the strength training business over the long term.

We know that the platform is versatile. While there are competitors that maybe aren't as focused on the bike portion, but all kinds of yoga and different types of classes you can take with an interface maybe on your iPad, etc. Since Peloton has these customers, they start with the hardware. They've got really, I think, an easy ramp into other types of training and classes and subscription-based products. That's a strength that you pointed out. They're looking to hit 100 million subscribers over the long term, which is aggressive, because they only have 3 million [laughs] subscribers. So, you're talking about growing that base [laughs] by 33 times. But even if management is aggressively wrong with their assumptions, it's still easy to see that they've got a lot of growth ahead. They could be 50% off and that would still be a huge leap from 3 million subscribers. The one thing that you pointed out, after all this, is that not all the subscribers are going to be Peloton product owners. I think this goes to that opportunity that you see that's separated from the hardware, some are going to use other people's equipment, other companies' equipment, and some will just bring a yoga mat to start with. They'll start with that mat and the Peloton app. You're not required to own the hardware to subscribe to the app. Tell me, Emily, and this is great, [laughs] what could go wrong with this picture? [laughs]

Flippen: A lot could go wrong with this picture. I think, as listeners maybe heard me express my extreme skepticism on the product just a number of months ago, to have me now have it in my top-five, they're probably scratching their head. But the reason why I believe that this is a great opportunity is actually because I made a resolution in 2021, that I've had an issue with my entire career as an investor, which is I always devalue brands. I think I have a hard time understanding customer loyalty, brand loyalty, and these lifestyle brands that become so ingrained in their opportunity to sell, even to existing customers, that I miss the bigger picture. I've used Yeti as an example of this many, many times, but I'll throw it out there again, as a business that I thought was selling really overpriced coolers just for huntsmans and outdoor men, but in reality, they were selling a brand. It didn't matter how effective or ineffective the product was, people wanted to be part of the Yeti lifestyle and I can see the same argument being made here, and the same argument having been made for companies like Apple in the past.

I like the fact that Peloton is doing more than just selling bikes. I think that's the first mistake I made here. Of course, the risk is that they don't have a great retention into 2021 and beyond as people go back and exercise in different locations, go to classes, go to gyms. But I think that more likely than not, they'll retain the customers that they've obtained and there is an eight to nine-week backlog right now on just getting the bikes. The business is looking to expand into things like treadmills, again, higher-end products but expanding the product suite means it could get into fitness classes for strength training as well. We see these smaller businesses crop up and try to sell app-based strength workouts with weights and bars and sets at home. Peloton hasn't tapped into that market yet, and I think they could in the future. Then more importantly, I think it's just the branding aspect. When I got my NordicTrack, for instance, I went into Amazon, tried to find just a cheap mat that I could put underneath my bike and I was shocked to see how many Peloton branded mats there were going to be. The business is selling just Peloton-branded products that are $50, $60 more expensive than their competitors and they're selling like hot cakes, because it's such a lifestyle for their users. So I'm excited about this one. I think it's fair to say that maybe this is the one that you're most skeptical about, Asit, that maybe wouldn't have been on your list?

Sharma: I think so, but we discussed before Yeti, I missed out on that too. We discussed that on a podcast. That's a great analog for this, because there can be a delta. There can be some differential between the time a company is firing on all cylinders financially and the time it takes for its brand to just show up one day, like, hey, I've been here all along, now look at me, I'm a monster. And that's what happened with Yeti. It took the pandemic to bring that out. But if you look at their financials, even before that, it was clear how much direct-to-consumer business the company started doing. Everything that they were saying about their brand being a lifestyle brand and very prized by its consumers, that proved true, and I hear similar themes when Peloton's management talks.

Our good friend, Tim Beyers, is a big fan of this stock, and he also talks about that brand strength. This is a good exercise for me, because I also need to be able to pay attention when, and I should stop myself here, because many brands are pretenders. [laughs] But when there is a brand that is truly going to take off in the marketplace, and it's visible, when it's visible, I have to learn how to go ahead and invest. Despite those misgivings, I don't have to mortgage my house and put it into Peloton, but I'll take a position. This is going to be a good learning experience for me. It'll make me a better investor. If it doesn't, it's just one out of five in the basket, we've got all these strong tickers. It's going to be alright.

Flippen: Well, hopefully I don't make you lose maybe there, Asit. [laughs] I guess I'll take you out to drinks or something in the future if I'm wrong, my treat. But the last stock that we have here on the list is another Asit pick and I'm happy you put it on there. It makes this collection of consumer goods companies a true molly collection of businesses. But I'll let you talk a little bit about why you're excited for this opportunity.

Sharma: Sure. One is just the idea of portfolio construction. We're putting together a basket, we've got some stocks that were swinging for the fences on, we've got some that we're excited for. I thought it'd be nice to have an anchor stock that maybe it's going to put people to sleep at the last bit of this podcast, but I'll speak more clearly and loudly so you don't fall asleep. I'm talking about Dollar General, simple DG. Now, why do I like a dollar store so much? Is that any good business? It's a great business. In fact, I call this a stealth candidate for a consumer goods portfolio, because if you're not familiar with Dollar General's performance, you may be surprised. Shares are up 116% in the last three years. They're up 224% in the last five years, and they've gained 667% over the last 10 years.

There are many tech names that I can think of that have had shooting stock performances for a few years, but over a 10-year period, when you stretch it out, this is actually up there. Maybe not the biggest and baddest tech stock performance, but this looks like a tech stock. Why has it been able to do this, and more importantly, how? Well, for beginners, it's the largest dollar store operator in North America, and it has flexible price points of $1 dollar to $10. Why is that important? Many Dollar stores start out trying to offer everything for $1. In fact, Dollar Tree, its big rival, did that for years and years and years. By calling itself a dollar store, but having these flexible price points, Dollar General was able to build more operating margin over the years because it wasn't trying to sell every product at $1. In fact, Dollar Tree had to buy Family Dollar so that it could also compete on flexible price points, which they've had mixed results for.

This is one of the few consumer goods retailers, not just in the dollar store category, but all around, that consistently grows its top-line by high single-digits and sometimes greater. They often have double-digit earnings growth in any given quarter. The way they do this is through a very simple formula. They have always had a very, I think it's almost a maniacal [laughs] real-estate strategy. I talked about Sleep Number at the beginning of this podcast. For the next few years, they want to grow their store base by 5% compound annual growth rate. Dollar General wants to do this forever. Year in, year out, they're growing their store base by 5.5% or 6%. Even in the pandemic, they grew their store base and selling square footage by about 5.5%. They've got a network of 17,000 stores. That's how big they've gotten just by going into under-served rural areas.

When you think about being able to grow your revenues by, let's say, 5.5% each year, because you're opening that many new stores, if you can add 3% to 4% of comparable sales growth on top of that, each store is selling that much more, you can get to 8%, 7%, 9% growth in a given year. Investors have realized this over time, that they've got these really super steady margins. Also around 31%, may remind you of Grocery Outlet. They don't change very much from year-to-year. They keep ongoing real estate projects on their books. They were so busy during the pandemic. They had an add of 1,050 stores. They did 1,750 remodels and 100 relocations during the pandemic. That's 2,900 real estate projects that they have completed actually, over the last trailing 12 months.

Their return on invested capital is pretty high for a dollar store retailer, it's at 24%. They are a cash flow machine. Yes, the 31% gross margin, you're going to have to sell a lot of goods to [...] some nice profit out of that. They had $32 billion in sales in the last trailing 12 months. But out of that, they generated $3 billion in free cash flow. A lot of this money goes into opening new stores, but they also repurchase shares because they tend to use operating leases wherever possible. They have cash on their balance sheet. I'm not a huge fan of share repurchases. I always start to think, well, why couldn't you invest the capital in your own business? But there are some businesses where it makes sense, and this is one. Over time, they've been reducing their share count. If you look at it, just a graph, you can see that the share price is outstripping the market cap growth.

Sometimes you get diluted, you're issuing shares and you're diluting shareholders. This is going the other way. Fewer shares, and that's helping the share price to rise higher as shares are in demand. In this case, I sort of like it. As for how they conducted their strategy before the pandemic, they were very much trying to open more coolers within every store, so adding grocery space. Because in rural areas, that's what brings people in each week, and sometimes on a daily basis. If you live in a food desert, you're going to Dollar General as your primary grocery store or Dollar Tree. That strategy really helped them over the past few years. They're continuing to do that. They've also introduced some experimental treasure store concepts in their stores. Just to play around with other ways they can continue to make sure their traffic is always flowing. They did a lot of work on their supply chain before COVID and their distribution to increase margins. We'll have to wait, I think now until next year to see what the true results of all that investment was, because the world has been upside down and they've had tremendous comparable sales, but have really been just throwing all their resources into making sure they can sell into this great demand.

Just to wrap this one up, I like that it trades at around 19 times forward earnings, so it's not expensive by any means. It's very purchasable, buyable right here. I think that the company is going to keep with this basic formula, it's going to be a quiet grower. But if no one pays attention and you can double every two to three years, why not buy some shares? Now, what I said at the outset, I own one of the companies that we discussed today. I bought Dollar General because it's a dividend stock. It's probably going to grow it's dividend, it's got great cash flows. It occurred to me watching it last year that this is a growth stock in the consumer goods industry.

Flippen: I'm never upset about having another dividend company in my portfolio, I think. But right now, the only dividend paying companies I own is a Cannabis REIT called Innovative Industrial Properties, which is probably not the safest dividend play. I think if you're investing in that, you're not necessarily doing it for the steady dividends. Then actually Constellation Brands as well. It's a much smaller dividend though and as a 26 year old, I don't think very much about dividends when making investments. But when there is overlap between great growth investments and a business that generates so much free cash flow, that they're paying dividends and repurchasing shares while still growing their value of their equity, as you mentioned, something like 200% over the past five years, it's absolutely amazing. This is also one that I'm not sure I would have owned before doing this show, because I never think about these businesses as being particularly attractive. But you make a really compelling case. So, another one that I'm excited to add to my portfolio and check-in on over the next couple of years.

Sharma: Awesome. We'll see how it goes.

Flippen: We'll see how it goes. I look forward too to sum up our consumer goods 2021 baskets, going to be made up of Sleep Number, Grocery Outlet, Beyond Meat, Peloton, and Dollar General. Somebody in the live chat here very smartly suggested the name "The Shopping Basket," which I love. Until we have anything better, if we have anything better, that's going to be our consumer goods 2021 shopping baskets.

Sharma: I love it.

Flippen: Asit, I really appreciate you spending so much time, especially talking and prepping for this show, while I've been a little bit sick. I really appreciate it.

Sharma: Well, Emily, I have to pay you the rare compliment here. Even under the weather, your under the weather is better than most people's perfectly fine. [laughs] Thanks for all the insight and you have some intriguing symbols that you've brought to the table today. I'm excited to follow this basket and see what happens.

Flippen: I am too. My voice sounds much worse than I feel, which is a nice thing. Whatever is traveling through me right now, it is, again, I tested negative for COVID, so goodness, not that. But whatever it is, it's making my voice sound a lot worse than I feel, so this show is a pleasure to do with you. Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out to say "Hi," you can always shoot us an email at [email protected] or tweet at us @MFindustryfocus.

As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work behind the screen today. For Asit Sharma, I'm Emily Flippen. Thanks for listening and Fool on!