A famous Omaha native once commented that "If Fed Chairman Alan Greenspan were to whisper to me what his monetary policy was going to be over the next two years, it wouldn't change one thing I do."
Those of you who guessed Fred Astaire have the wrong Nebraskan. As you might have suspected, this nugget comes from ever-quotable Berkshire Hathaway
Buffett doesn't care about the Fed because he doesn't have to. Over his long investment career, he has handpicked a stable of companies that are as close as possible to immunity from monetary fluctuations -- veritable battleships capable of handling anything Alan Greenspan or anyone else might throw in their course. Provided that they are managed competently and purchased at a reasonable price, these companies and their stocks should do fine in inflationary or deflationary, fast- or slow-growth, environments.
Several anchors of the Berkshire portfolio, such as Coca-Cola
Building ritzy condo complexes in south Florida with names like Sapphire and Tao may attract headlines and inspire harmony between developers and buyers, but the companies that consistently sell millions of smaller goods or services make their shareholders the most money over the long haul.
In his extremely valuable book The Future for Investors, Wharton professor Jeremy Siegel presents summaries of S&P 500 performance since 1957 -- the first year of that index. Siegel characterizes the best performers as "corporate El Dorados," dominant companies with fat dividend yields, business niches, and staying power.
I interpret Dr. Siegel's fascinating evidence slightly differently: I believe that his appendix (alone worth the price of admission) reveals that many of the real "El Dorados" over the long term have been purveyors of branded consumer staples products. Check out the performances of a selected group of these, with dividends reinvested (according to Siegel):
|Cadbury-Schweppes (previously Dr. Pepper)||18.07%|
|Procter & Gamble||14.26%|
When you consider what a great time 1957-2003 was for growth stocks, many classic "defensive" stocks appear to play pretty good offense.
Lots of these companies were turning in eye-popping performances well before Professor Siegel's sample period. Thumbing through my 1940 edition of Graham and Dodd's Security Analysis, I was surprised to find that during the thick of the Great Depression, while scores of financial, industrial, and consumer discretionary companies experienced bankruptcy and earnings collapses of 90% and more, Coca-Cola's earnings actually increased from $2.56 in 1929 to $5.95 in 1938. Fortunes destroyed, mayhem, havoc, financial hell on earth -- and Coke shareholders saw their company's earnings increase by 232%.
Defend yourself with a candy bar
So why have consumer staples companies enjoyed such success over the long term? There's that mystical thing called brand power, the consumer voodoo that entices you to pay 75 cents for a Dr. Pepper, even as you politely decline a Dr. Thunder. But a few other characteristics come to mind as well:
Product demand is always resilient. This rare advantage gives consumer staples their defensive reputation. Since people have to buy razors, toothpaste, and shampoo, purchases remain robust even with sharp fluctuations in consumer prices and incomes. How bad would a recession have to get to keep you from buying soap? Soft drinks and candy bars become affordable luxuries as shoppers substitute them for more expensive indulgences. Similarly, during inflationary periods, branded staples companies can pass on costs to consumers, who accept higher sticker prices on items they have to buy.
They're relatively easy to understand and operate. Moving parts may be great in cuckoo clocks and action movies, but in companies, too much excitement can complicate matters. Wrigley mixes gum base together with flavorings and softeners. They roll it into strips. They wrap the strips of gum, and they sell them. Then they do it again and again, laughing their way to a near $16 billion market cap and net margins of 13-14%. Embrace simplicity, Grasshopper.
- They can reinvest at a high rate of return for a very long time. Neil Young wrote, "It's better to burn out than it is to rust," but if you have a choice, you don't want your companies to do either. In my opinion, one of Buffett's least understood yet most important arguments is that good businesses are able to consistently invest incremental capital at high rates of return. Continuously profitable allocation explains why money compounds and why it tends to happen more reliably in consumer staples than in many other industries.
It's easy to see the problem with companies that "rust," stagnating and collapsing because of anemic earnings, such as Bethlehem Steel. This onetime American industrial titan died a lonely death in 2004 after decades of struggles against overseas competitors with access to cheaper labor and domestic foes with aggressive management that embraced technology, such as Nucor and U.S. Steel.
On the other hand, consider the hypothetical company Feast & Famine, Inc., whose management is expanding operations at a breakneck pace. Soon enough, though, as the company saturates its market, management finds it much harder to match the earlier return on each invested dollar. Since they want to please shareholders (and to help their own options exercise at a high share price), the executives continue to invest, moving cash into projects that they don't have any particular knowledge of or aptitude for. Margins collapse, and the company has trouble servicing its debt and subsequently goes bankrupt.
This scenario may be dramatic, but the floor of the NYSE is littered with the corpses of Feast & Famines. Moral of the story: burning out may be slightly more fun than rusting, but neither is a particularly pleasant experience.
Realizing how hard it is to grow at a measured pace for a long time can give you a new appreciation for a company like Arm & Hammer manufacturer Church & Dwight
Dishing the (consumer) goods
Stocks of consumer staples companies don't appear screamingly cheap right now, but they don't look particularly expensive either. On valuation, I have to side with Oakmark and OakmarkSelect manager Bill Nygren, who has been arguing for some time that the market is offering up a number of above-average businesses at average prices. The Consumer Staples Sector SPDR
You'll have to do your own valuations to make sure you're not taking on the opposite of a margin of safety (a "margin of peril," as Fool Chuck Saletta put it). But your job as an investor is to make money over the long term no matter what the economy does. Why not buy stock in companies that survive in hard times and prosper in good ones?
Both Coca-Cola and Anheuser-Busch are Motley Fool Inside Value recommendations. Want to see which other companies have made the cut? A free, 30-day trial is yours for the taking. There's never an obligation to buy.