The Best Buys in Today's Market

It's an interesting time for consumer-staples stocks, Fools. Certain sector names have now outperformed the market year to date -- J.M. Smucker (NYSE:SJM), for instance -- while laggards such as Procter & Gamble (NYSE:PG) have badly trailed the rally and lost money for investors on an absolute basis.

With that in mind, let's review the sector's recent performance, to see whether further gains are the stuff of Kool-Aid dreams or PB&J reality.

No-brainer buys long gone, but ...
Looking back to the March lows, the depth of the market's fear was perhaps most clearly seen in the stocks of historically stable packaged-foods producers such as Kraft (NYSE:KFT) and ConAgra (NYSE:CAG). The price-to-sales ratio on these names dipped beneath 0.75, to multiyear lows, reflecting expectations of widespread deflation and a new consumer preference for bread-and-water victuals.

For now, the days of extreme fear and remarkable buys are a thing of the past, but as the table below indicates, consumer-staples valuations appear far from stretched.

All data current as of Oct. 19. Price performance data from Reuters; forward P/E from Yahoo! Finance; five-year average P/E courtesy of Forbes.com.
* Total return
** Standard & Poor's bottom-up estimates based on operating earnings.

Notably, even the strongest performers trade at forward P/Es substantially below their five-year averages. That alone could be construed as a strong buy signal. Consider that not a single staples company has cut its dividend this year, then add in the sector's low historical volatility, and you've got a perfect recipe for high risk-adjusted returns.

Just for the stodgy and scared?
Let's say you believe that the economy is poised to make a comeback. Strategists' advice to reduce consumer-staples exposure in favor of discretionary names undoubtedly seems logical. However, the sector has already priced in some pretty heady expectations, potentially limiting your upside as reality catches up to hope.

We've already established that many consumer-staples stocks trade at a low historical valuation. Well, a true economic recovery would usher in more confident consumers, leading to increased volumes, firmer products prices, and an all-around improved environment for companies that sell everything from name-brand bleach to premium-priced men's razors.

Take the case of P&G. Since the recession took hold, the company's been plagued by cash-strapped consumers trading down to lower-priced products. Recently, management gave in and lowered prices across 10% of the product portfolio. Should those conditions reverse, and the stock trade up to its five-year average P/E, investors would enjoy a 23% gain -- all while taking on substantially less relative risk and collecting a modest dividend. With ConAgra, Energizer, and Kraft, the return would be even greater.

In that light, why wager on some potentially overpriced retail name?

True, but ...
There's one problem with the scenario that I outlined above: More confident consumers don't necessarily translate into brisker business for companies that sell name-brand goods. Private- and store-label wares have deepened their foothold during the recession, and consumers plan to trot their value-minded ways right on into a recovery. So even if you're convinced that personal income and credit conditions are poised to improve in the next year or two, shoppers may be more likely to spend their extra dough on a Gap (NYSE:GPS) sweater or Crocs' (NASDAQ:CROX) latest fad than fancy laundry detergent.  

All of which means that business conditions may not propel consumer-staples P/Es back toward their long-run averages, emboldened consumers or not.

Now that we've got the pros and cons out in the open, you're probably itching to know: Are these stocks a buy or what? As a sector, maybe. In terms of individual companies, I believe there are some definitive yeas and nays. Valuation is a good place to start, and the table above might offer initial ideas.

Further Foolish factors worth considering:

• This company has a tasty product mix.
• Geographic exposure is another key factor.
• Finally, you gotta be able to trust management.