Consumer Goods Stocks to Watch

In this podcast, Motley Fool senior analyst Bill Mann discusses:

• The market pre-reacting to the Federal Reserve's announcement.
• Why large companies like Microsoft are quietly preparing for 2023 and 2024.
• The charges against Beyond Meat's chief operating officer.

Motley Fool host Alison Southwick and Motley Fool personal finance expert Robert Brokamp talk with Motley Fool senior analyst Emily Flippen about some of the biggest consumer goods storylines of the year, and stocks to watch in the sector. 

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Sept. 20, 2022.

Chris Hill: Despite what you may have thought, Wall Street is not waiting patiently for the Fed's announcement on interest rates. Motley Fool Money starts now. I'm Chris Hill, joining me today, Motley Fool senior analyst Bill Mann. Thanks for being here.

Bill Mann: Hey Chris, how are you doing?

Chris Hill: I'm an investor. That's how I'm doing, Bill. I'm an investor in the stock market where we are just tiny boats and an enormous sea that at the moment is being controlled by the Federal Reserve.

Bill Mann: Are you making a Ty-D-Bol reference? Is that a Ty-D-Bol reference? You remember the guy and the little boat and he would sit literally in a toilet?

Chris Hill: Yeah. I think there's a reason they don't do those commercials anymore.

Bill Mann: It's exhausting, isn't it?

Chris Hill: I understand investors who get down for all the talk. John Rotonti and I had a great chat yesterday about the pessimism in the market and trying to rise above that because this truly is where opportunities for long-term investors live. They live in these situations. It doesn't mean that it doesn't get tiring and deflating at times. When I see, hey, investors collectively have decided that whatever the Fed announces on Wednesday afternoon is going to be awful. We're just going to collectively sell off stocks. It's like, hey, maybe we can just wait and see what the Fed announces. How about that as an idea?

Bill Mann: Instead of treating it like it's the next Pee-wee Herman movie. It's going to stink. Whatever it is that they've got coming. It's funny, Chris, and I don't mean funny ha, ha. It is always strange to me. We had conversations in 2019 in which we tried to describe to people what a bear market felt like because in 2019 and even 2020 we didn't get a real feel for it. It's not the fact the market goes down a lot because that happened in 2017, it happened in 2014. It happens all the time. It's the relentlessness. It's the fact that it doesn't end. They say, it's the hope that kills you, it's ultimately the lack of hope that I hope people who are listening to this really do understand that this too shall pass, 100 percent chance.

Chris Hill: Yes. If history is any guide, when it does pass, there will be some stretch of time where the companies that we've been talking about for a while now, the companies that there is no doubt in our mind, they're going to come out on the other side stronger. In some cases, they will be stronger because the competitive landscape has gotten more favorable to them not because they have risen, simply because they have maintained whatever status they're at and their competitors who are smaller and weaker continue to get smaller and weaker. When that happens, I think we're going to see investors falling all over them. I'm talking about like Wall Street professionals falling all over themselves to buy into rising stocks.

Bill Mann: It's funny you say that you and I talked for a little bit offline about the fact that it seems like people are losing their minds now. I really think that it has a lot to do with the fact that we as humans really don't like change. The change that we're going through now, the change that we're experiencing is that there is no such thing anymore as the Fed put underneath equities. The Fed is primarily interested in inflation. Inflation at this point, depending on how you measure it, their target rate is two percent and we're at somewhere around eight. I don't need a calculator to tell me that that's four times too high. When we're talking about an environment in which the Fed is no longer making things accommodated for every company, the thing that people have to remember is that for the well-structured, well-financed companies, even though they have to go through the shadow of the valley of death as everybody else, it's good news. That capital is more expensive because that ultimately will remove less well-heeled, less well-financed competition from the mix.

Chris Hill: It's a great point and it's something we haven't talked about in a while. But no, you're absolutely right. Like if you're Microsoft, yes, you are looking at your budgets, you are checking all the boxes to make sure you are not being particularly wasteful. Although some have argued that that should be an ongoing process. But if you're Nadella or any of his lieutenants, you have to be very quietly licking your chops.

Bill Mann: Absolutely. You're cracking your knuckles and waiting. One hundred percent true.

Chris Hill: At what 2023 and 2024 will bring. We'll see whatever the Fed announces Wednesday afternoon.

Bill Mann: It's going to be terrible. That's what the market is telling us. Whatever it is, it will be a mistake.

Chris Hill: It's my favorite quote of Winston Churchill's. When you're going through hell, keep going. Let's move on to a story just crazy enough to be true, which is that Doug Ramsey, the Chief Operating Officer of Beyond Meat, was arrested over the weekend before getting into an altercation in a parking garage following a University of Arkansas football game. What's catching everyone's attention is that part of this altercation is that allegedly Doug Ramsey bit the other man's nose.

Bill Mann: I did not have the Beyond Meat COO being accountable on my bingo card. I've got to tell you, Chris.

Chris Hill: None of us did. 

Bill Mann: I want to see that lottery ticket.

Chris Hill: The company has not to this point, issued any statements and the cannibalism and meet jokes right themselves. But on a more serious level, I don't think the CEO of Beyond Meat had this on their bingo card as well because we're like, what do you do in this situation? It is not uncommon for a few times a year, the headline for a given business to be that the CEO is leaving immediately due to some sort of job performance impropriety, something a workplace relationships, something like that. This is someone who's been charged with third degree battery. If you're the CEO, if you're the Board of Directors of Beyond Meat, congratulations, you're now dealing with this. It's not enough to just deal with all of the regular challenges of running a public company. You're now dealing with this and what do you even do in this situation?

Bill Mann: Look, I think that we need to give a nod to the fact that the CEO and CFO and COO of Beyond Meat are dealing with a stock that is down 90 percent plus. They're dealing with a market that is highly competitive and they are barely able to meet their gross cost to produce their near meat. They've been under a lot of pressure. I say that only partially, not to excuse someone for biting somebody else in the nose because, obviously, that's not it. I ultimately on one level worry about this man's health. I worry about this man's psychological health. If that is the case, if there is something that's going on there, I hope that Doug Ramsey gets the help he needs. Because, let's just set the table here. I don't know how things were where you grew up in Maine. But in North Carolina, biting someone on the nose was not a way to settle conflict. Nose meat is not the other white meat.

Chris Hill: No, absolutely not.

Bill Mann: I don't know how the Board handles this. I don't know that much about about Mr. Ramsey. He has not been in the job all that long. He came over from Tysons, which just adds to the potential of even making it a conspiracy that he was some Manchurian candidate to come in and start eating human flesh as a way to humiliate Beyond Meat. I don't know what kind of job he's done. He will have to answer for his crimes. I do really hope that if this is something that is a sign of greater damage in this man's life that he gets help for.

Chris Hill: Well-put. Bill Mann, always great talking to you. Thanks for being here.

Bill Mann: Thank you, Chris.

Chris Hill: If you were making a list of consumer goods companies, would you put Netflix on it? Today, Alison Southwick and Robert Brokamp continue their sector series with Emily Flippen, and they look at some of the biggest consumer goods storylines and some investment ideas to put on your radar.

Alison Southwick: This week is the last in our series tackling different sectors of the market and getting you up to speed on what you may have missed over the summer now that pumpkin spice is in the air. This week, we're joined by Motley Fool analyst Emily Flippen to cover consumer goods. I hope your bingo card has inflation and supply chain on it, but before we get to that, Emily, thanks for joining us.

Emily Flippen: Thank you so much for having me.

Alison Southwick: What are we talking about when we're talking about the consumer goods sector? Because I'm picturing T-shirts, tennis shoes, and gallons of milk.

Emily Flippen: You're not wrong. In fact, I think the traditional definition for consumer goods is just any company that is selling physical items to regular consumers, like you or I, so not necessarily merchants or other intermediaries. But I've always taken a bit of a broader definition of the consumer goods industry, which has often been to my peril, but we'll get into that. My definition is really any business for whom the majority of their revenue is driven by consumer purchasing. While the traditional definition I think has a pretty heavy focus on physical items, I personally like to extend it to services as well. In my opinion, a company like Netflix could be considered a consumer goods company because they are heavily dependent upon consumer spending. Of course, that is a controversial opinion. 

Alison Southwick: I was going to say, you made both Bro and mine's eyebrows go up when you said that.

Emily Flippen: Part of it stems from my desire to talk about a wide swath of companies that isn't your traditional retailers, restaurants, or e-commerce. Because I think a narrow view of consumer goods can steer people away from some really interesting companies that still play off the same trends and tailwinds that affect consumer spending. My opinion may not be the opinion that works for many investors, but it's the one that has worked for me.

Alison Southwick: With that being said, when you look at the holdings of like a consumer goods ETF, you're going to see names like Coca-Cola, Nike, GM. Are those more like called consumer staples, discretionary, is there a difference between the people who make the things versus the people who sell the things?

Emily Flippen: Yes, definitely. I love that differentiation, the consumer staples versus the consumer discretionary. Their name gives them away. But the consumer goods industry can be broken down into two types of spending. That's spending that happens as a necessity, as a part of everyday life, and there's portion of spending that happens that's discretionary or with excess slash funds that consumers like to spend but maybe you don't have to spend on a regular basis. When I go to the grocery store, I will always buy a gallon of almond milk. I think everybody does. It's always sold out. But I'll get my gallon of almond milk. That's a necessary spend for me, I drink that, I consume that every week. But maybe a non-necessary spend for me will be some makeup that I purchased on the way out or special treats. That's a difference between the necessary staples versus the discretionary.

When you're breaking down, and analyzing businesses that maybe sell necessities versus discretionary items, it can get really interesting. Because typically, the necessaries are items that are more stable, I suppose, because people are going to be buying them regardless of how the economy is doing. The spending doesn't shift as much as they do for discretionary items, but they also have less pricing power. Price of my almond milk goes up too much. There's a lot of substitutes that I can buy for the almond milk in this case, whereas the discretionary item, my makeup, maybe I'm more brand loyal to that makeup. When you're investing in this industry, you can do the risk reward trade-off between the two with consumer necessaries or staples in this case being lower risk, but also lower reward, and the discretionary being higher-risk, higher-reward.

Alison Southwick: What are you focusing on when you are looking to invest in consumer goods companies?

Emily Flippen: I think the one aspect that really applies for consumer goods companies, and this applies about this staples and the discretionary items that tends to be overlooked by a lot of investors is the brand power, and it's easy to be overlooked because it's not a quantitative metric. You can look at a lot of quantitative metrics for many different businesses and we can get into some of those, but the one that I think drives way more of the sales and the margin and the market is willing to lead on is just the perception of a brand in a consumer's minds, and it's so qualitative, it's really hard to capture. There are some metrics like Net Promoter Score, NPS, that some companies survey for to get a sense about how the customers are feeling about their brand and whether or not they'd recommend the brand to other people. But these are still trying to quantitatively analyze something that's inherently qualitative, and I think having a great understanding of the brand that's underpinning any consumer goods investment is really critical for getting an idea about the business itself because that's going to tell you a lot about how sticky it's customers are, if the business has pricing power, and what the long-term growth prospects could look like.

Alison Southwick: Because I can imagine for something like in the fashion industry, brand could be pretty fickle or it could get hit, a sudden thing could happen that could hit a specific product so that people aren't going to use it for a while. Brand can just seem very fickle as well.

Emily Flippen: Yes. There's brands and there's also trends. You'll have a lot of businesses that are playing off maybe a one-time trend and they think what they're doing is building up a really strong brand. But in that case, people are more loyal to whatever the trend is as opposed to being loyal to the brand. It's important to differentiate between those two. But to your point, brand is something that is constantly changing and evaluating. You need to have a good understanding about what you use to evaluate brand in a business, and in my case, a lot of that is great boots on the ground research.

Using your brain, even if the metrics maybe aren't painting the full picture, reading reviews that you can find online, all of these things influence how a brand is perceived by consumers. To your point, that can change very quickly. I'm trying to think about a good example, Peloton, maybe one business that at one point had such a premium brand that has been so horribly devalued by its post-COVID experience that now they're selling on third-party marketplaces like Amazon, where they wouldn't be caught dead only a couple of years earlier. That does dilute the value of Peloton's brand. Having a good understanding about the strategy that both consumers and management take with that certain product is critical for, I guess, evaluating the differentiating factors of business' brand.

Alison Southwick: Staying in the gym zone and also, if you remember, Lululemon and all the like, their brand took such a big hit for a number of different reasons, but they were totally able to bounce back and see incredible returns over the long term. What about like physical retailers? Are there different metrics that you look at there?

Emily Flippen: For physical retailers, it's actually a lot easier. Brand is still important. To your point, Lululemon is a great example of that. Don't discount the value of that, but you can also look at more quantitative metrics. For any physical retailers, you have something like same-store sales, where they're analyzing the sales in a particular store year over year and how that's evolved over time. Sales per square foot, which is exactly what it sounds like. Measuring the efficiency of a selling space for a physical location and even the lifetime value of a customer in comparison to its customer acquisition costs.

All of these things are great, real metrics that drive at the value of a brand. If a brand is strong, those typically tick up over time. For example, Lululemon, they have consistently expanded their net sales per square foot. Same-store sales have grown. For businesses like Chewy, for instance, which I think has an impressive ability to drive brand loyalty, that is also a business that has expanded its lifetime value of its customers, kept his acquisition costs low, all highlighting how powerful those brands are. The business models are just that much more efficient because the brands are really prominent and strong.

Alison Southwick: Between COVID, supply chains, and now, inflation concerns, the sector has been making a lot of headlines. But how would you sum up the last year or so? Simply Awful, sorry.

Emily Flippen: I can go now? No, it's a great. You nailed exactly what's been happening to this industry and it's more of the same. Everything is supply chain COVID, inflation margins going down. The one thing I'd add is actually inventory, and maybe this is the accumulation of all of these factors now showing up on the balance sheet for a lot of consumer goods companies. But physical retailers, businesses that hold inventory on their balance sheets. I've had a really tough time navigating the past couple of years, because they couldn't get supply, because its supply chain constraints, and now they're in that position of having to make up for what is it delayed backlog of demand while also trying to predict it that demand could look like in an extremely challenging environment, both with inflation and fears over consumer spending falling down.

We've seen a lot of retailers have bloated levels of especially discretionary inventory on their balance sheet, with Target being a prime example of that. Over the past quarter, they doubled their inventory year over year mainly in things that are not selling through discretionary items like TVs. That's going to be challenging for that retailer Lululemon, since we're on the subject, I think they've grown their inventory at nearly 20 percent CAGR over the past three years, really well-positioned in terms of inventory headed into the holiday season. But if that inventory doesn't sell through, these are going to be retailers that have to discount that inventory to get that to move, and when you're talking about the quality of the businesses brand, in this case Lululemon you can understand how discounting inventory would be very degrading to what is normally a very strong brand.

Alison Southwick: The holiday season is fast approaching, which is the most wonderful time of year for the sector. Meanwhile, everyone is worried about, like you said, inflation but combating inflation also means that we're worried about creating a recession. What's your take?

Emily Flippen: I'm so interested to see how this holiday season is going to play out. Because as you mentioned, we have two narratives happening right now. Some CEOs of some businesses are saying, "Man, things are looking bad. We're not feeling super grade headed into the back half of the year. They are lowering guidance both on the operational side, but also just from demand falling. While other companies are saying, no, we expect demand to remain high. Consumer spending has not fallen the way that we have expected it to, despite rising inflation and interest rates, and we're prepared for a really strong holiday season, we'll start to see the first inklings of that as we head into the holidays here about what spending could look like. My personal expectation is that we're probably not going to have a blowout holiday season, but it's not going to be the disaster that some investors expect it to be. I expect it to be relatively strong. But to your point, the economy can change very quickly and consumers are fast to adjust their spending if they see hard times on the horizon.

Alison Southwick: As before, we like to give our listeners a stock to watch or put on their radar. What is a stock that you think are listeners should be keeping an eye on?

Emily Flippen: One stock that I've been keeping an eye on and I still have questions about it to be clear, but it's certainly on my radar more and more with each passing day is actually Sweet Green. The ticker is SG, and I think if you live, especially in the New York Metro area, you're probably familiar with this company, they're fast casual salad chain, and they went public maybe a year or so ago, and I had a lot of questions about their strategy to expand into the suburban market. Because I have to be honest. They sell $15 salads and I don't know, it's hard to get me to eat a salad in the first place, but also paying $15 to do it. It sounds like a hard bargain for the suburban Americans out there.

But in their most recent quarter, despite a lot of slowdown because of that consumer purchasing that we just mentioned, they actually had really strong strength in their urban, or they're suburban markets, despite more than a third of sales coming from the New York area in particular, the suburban stores that they have built outs have just been incredibly strong and they have long-term plans to get to 1,000 locations across the United States. I'm pleasantly surprised with how effective that expansion has been. This is a company that has some, again, going back to the metrics, some really impressive metrics including restaurant-level margins. While the business isn't profitable itself, the restaurants are increasingly profitable with time. It's certainly one that is on my radar. I have not bought it personally myself, but I'm watching it more and more each day.

Alison Southwick: I'm going to say it's due to the Green Goddess salad. Oh man, that ones.

Emily Flippen: Put avocado in anything,

Alison Southwick: Right, it's so good. I believe you also have a stock for us to avoid?

Emily Flippen: Yes, the stock that I have to avoid right now, and admittedly, I could be wrong as a Sweet Green, but it's actually Bark at trades under the ticker, BARK, believe it or not. They're the owner of BarkBox, which is the subscription service for dogs, like Stitch Fix for dog toys, if you can imagine it like that. The reason why I call it out as a stock to avoid in particular, is because I think there's a lot of belief from investors that the pet industry is really recession-resistant, which has historically been relatively true in comparison to other sectors. But when you're a business like BarkBox, even though you do play off the trends and pets, that is still very discretionary spending. They aren't necessarily selling the cat litter or the dog food, they're selling stuff that can be easily cut from investors and consumers budgets with time. That also alongside the fact that it's a business that has and in my opinion, a relatively weak brand, poor margins, and it's pretty unprofitable. It's one that for the time being, I'm just avoiding.

Alison Southwick: Now Bro, for investors looking to add maybe some broader exposure to their portfolio, to the consumer goods sector. Do you have like an ETF or a fund for us to consider?

Robert Brokamp: I most surely do, and I would say it's certainly something to consider for those of us who are Motley Fool investors tending maybe more toward growth and tech-oriented type of stocks. Something to consider to add a little bit of diversification portfolio might be the Vanguard Consumer Staples ETF with the ticker VDC. The companies here tried and true. They're the top 10 holdings are Procter & Gamble, Coke, Pepsi, Costco, Walmart, those types of companies, Estee Lauder, Colgate, Palmolive. These are holding up much better than the overall market. So far this year the S&P 500 is down 16 percent, Nasdaq down 25 percent, but this ETF is only down six percent. Another way to measure the volatility would be its Beta. According to Morningstar, the Beta of this ETF is 0.6. What does that mean? Well, if you have a Beta of one, you're as volatile as the market. If you have a Beta greater than one, you're a little bit more volatile. This has 0.6. so it's about 40 percent less volatile than the overall market. Plus it has a decent dividend yield of 2.3 percent compared to the 1.6 percent from the S&P 500. I think this would be a good way to add a little bit more ballast to maybe the more aggressive side of your stock portfolio.

Alison Southwick: Emily, I want to thank you for joining us and closing out our series here. What is your parting advice for investing in the consumer goods sector?

Emily Flippen: This is one sector where boots on the ground research can be really valuable and it can be easier to write off experiences as anecdotal. But if you're an investor, if you're interested in investing in Chipotle, get out and go to a Chipotle or a Walmart or Target. This is one of those industries that lends itself really well to those personal experiences. It helps you get an idea about the value of a brand and can give you some, I guess, inside scoop in your investment and make you personally interested in following it alongside when you have this personal experiences to back it up. Don't be afraid to get out there and just experience these companies for yourself before making an investment. 

Chris Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy yourselves stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.