Investing in Consumer Staples Stocks

Whether you think about it or not, you probably rely on consumer staples companies every day. Consumer staples are daily life essentials like food and beverages, cleaning and personal hygiene products, household products like paper goods, and alcohol, tobacco, and cosmetics.

They’re the kinds of goods you buy and stock your house with regardless of the greater state of the economy, and the amount you buy or spend on them is relatively fixed. In this way, the consumer staples sector behaves much differently from consumer discretionary businesses like restaurants, hotels, and apparel. Consumer discretionary goods are best defined as wants rather than needs. They are products or services that consumers will purchase if they have sufficient income. With those kinds of goods and services, consumers tend to increase their spending and consumption in good economic times and pull back during a recession.

Consumer staples companies may not have the highest earnings growth or year-over-year revenue growth, because as market leaders, they are already large, mature companies. But these stocks make up for that modest growth with safety, reliable profits, dividends, and defensive positioning.

Advantages of consumer staples stocks

Consumer staples stocks function noncyclically, meaning they offer investors safety during recessionary climates. Since these companies sell products like food and cleaning products that consumers rely on regardless of the state of the economy, they tend to generate solid profits even in a weak economy. For instance, a number of consumer staples stocks have thrived during the pandemic as consumers stock up on essentials and avoid spending on things like travel and restaurant meals.

They are also generally defensive, dividend-paying stocks, meaning they tend to outperform in down markets. Some of them are Dividend Aristocrats -- stocks that have increased their dividend payout every year for at least 25 years. For this reason, consumer staples stocks are often popular with retirees and other investors seeking income and security. Many of them offer better dividend yields than the S&P 500, which pays a 1.6% yield as of December 2020.

Because these companies operate in a stable sector and sell products that are always in demand, the biggest consumer staples companies have been around for ages, sometimes a century or more. That’s a sign of their brand power, as well as their ability to endure a wide range of challenges and economic cycles, and it adds to their attractiveness as defensive stocks with healthy dividends.

Top consumer staples stocks

Just as you’re already familiar with many consumer staples products, you likely know many of the top stocks in the sector, such as Costco Wholesale (NASDAQ:COST), Procter & Gamble (NYSE:PG), and Pepsico (NYSE:PEP), which we discuss below.

• Costco Wholesale (NASDAQ:COST) is a little different from the typical consumer staples stock. The retailer doesn’t make consumer staples products, it sells them -- most of its inventory consists of products like groceries and household items such as paper products and cleaning supplies. Costco has a number of advantages over its retail peers, largely because its membership model provides a reliable customer base, with a retention rate around 90%. Costco also gets most of its profits on membership fees so it can offer rock-bottom prices on merchandise, making it hard to compete with as well as recession-proof. The warehouse retailer has thrived during the coronavirus pandemic -- comparable sales growth (an industry metric that factors out new-store openings) has jumped by double digits, and e-commerce sales are soaring as well. The company even rewarded investors with a $10-per-share special dividend, giving investors a direct benefit from the windfall.
• Procter & Gamble (NYSE:PG) may be best known for some of its marquee brands, which include Tide detergent, Gillette shaving products, and Crest toothpaste. The company is nearly 200 years old and has 22 brands that generate $1 billion or more in annual revenue. Nearly all of them are No. 1 or No. 2 in market share in categories including paper products, laundry detergent, diapers, and beauty products. P&G is also a Dividend Aristocrat with a history of innovation. It is currently developing products including nontoxic insect repellent Zevo, and in 2019 it released a line of plant-based cleaning products called Home Made Simple. After streamlining its business by selling off noncore brands, restructuring, and cutting costs, the company looks as strong as it’s ever been. Like other consumer staples stocks, P&G is getting a big boost from the pandemic. Organic sales, which strip out the impact of acquisitions, divestitures, and currency exchange, jumped 9% in the quarter that ended in September 2020, with strong growth in home care and healthcare products.
• PepsiCo (NYSE:PEP) is more than just its namesake beverage brand. The company also owns Frito-Lay and Quaker, as well as other popular beverage brands like Tropicana and Gatorade. Its Frito-Lay snacks business generates nearly as much revenue as its beverages do internationally, and that business has proven to be a source of growth while soda sales slow in the U.S. and internationally. With global brands and distribution, Pepsi enjoys many of the same advantages as industry giants like P&G and Coca-Cola (NYSE:KO), and it has also grown through acquisitions over the years. In 2018 it acquired SodaStream, which gave it a leading position in countertop soda making. Pepsi is also a Dividend Aristocrat, having raised its quarterly payout for 48 years in a row. The company has faced some headwinds during the pandemic due to its dependence on restaurants, but Frito-Lay and Quaker have been sources of strength, helping the company deliver modest earnings growth through the first three quarters of 2020.

Consumer staples ETFs

For investors who prefer to get exposure to the whole sector rather than pick individual stocks, buying an exchange-traded fund in the sector is the most sensible option. The chart below presents three different ETFs in the industry, Consumer Staples Select SPDR Fund (NYSEMKT:XLP), Vanguard Consumer Staples ETF (NYSEMKT:VDC) and iShares U.S. Consumer Goods ETF (NYSEMKT:IYK).

Source: Yahoo Finance

The first two of these ETFs have Costco, Procter & Gamble, and PepsiCo as their top three holdings, while the last one includes both consumer staples and discretionary stocks.

In addition, they own popular consumer staples stocks like Walmart (NYSE:WMT) and Coca-Cola as well as stocks like the following:

• Philip Morris (NYSE:PM)
• Mondelez (NASDAQ:MDLZ)
• Altria (NYSE:MO)
• Colgate-Palmolive (NYSE:CL)

Key metrics to watch

I've given you some of my favorites, but you can find great consumer staples stocks, too. In order to evaluate consumer staples companies and choose the best stocks, it’s important to understand some key industry metrics. Those include the following:

• Organic sales: This metric strips out certain factors and events that may affect revenue, such as acquisitions, divestitures, and foreign currency, and therefore gives the best picture of how the underlying business is performing. Organic sales growth is made up of two components: volume growth and price growth. It’s better for companies to grow organic sales through increasing volume, which can be understood as the number of units sold, rather than price hikes, because volume increases are more sustainable and mean increasing demand as well as market-share gains often. Price increases, on the other hand, help lift profitability, but brands can only raise prices so much.
• Market share: This is the percentage of total sales that a company or brand gets in a given category, like diapers or soda. Since consumer staples products tend to be slow growers and demand is rather fixed, companies are fighting over market share, or pieces of the same pie, rather than enlarging the market. That means market-share gains are key to showing strength, or competitive advantage. Companies don’t often report market share directly, but data is generally available from third parties. Companies also tend to note market-share gains when they are relevant.
• Dividend yield: Another key factor to use to assess consumer staples stocks is their dividend yield. Since these tend to be mature, highly profitable, and long-lived companies, they almost always pay a dividend, and their yields are generally better than that of the S&P 500. What investors like about consumer staples stocks is their defensive positioning and their ability to pay a steady dividend, as many of them are Dividend Aristocrats. Their well-recognized brands, marketing reach, and global distribution help create barriers to entry, protecting profits and ensuring their dividends. High dividend yield and reliable dividend growth also make up for sometimes modest earnings growth and help lift total return.

A timeless business model

Because consumer staples products tend to be timeless and the industry sees relatively little innovation, these companies are likely to endure for generations to come. Though they may not deliver the fastest earnings growth on the market, their ability to withstand recessions, increase their dividends, and put up consistent growth makes them excellent choices for investors looking for reliable, income-producing stocks that will help them sleep easy at night.