Are Consumer Staples all you need?

I’ve never really considered building a single category dividend portfolio before. Having said that, if I was going to, it would probably be made up of consumer staples. 

I love consumer staples as a dividend category. Many fine dividend stocks have come out of this group of stocks. I think of Procter & Gamble, Colgate, Kimberly Clark, Clorox and McKormick & Co in this broad basket. I’ve been historically underweight this category in the past, but it’s something that I’m keen to rectify.

I’ve recently been stockpiling McKormick and Company, Colgate (which I bought and then subsequently sold, only to rebuy!) and even Mead Johnson, which I consider more of a “childrens staple”. I’m not done with my accumulation of consumer staples. In fact, I’d like them to make up a far higher proportion of my dividend income.

What are the reasons for my interest in consumer staples?

Stable demand

I’m hard pressed to think of any other sector with such stable demand. During the recession of 2008/2009, many sectors experienced sustained revenue declines. Companies in the financial services sector such as Bank of America, Wells Fargo and JPM are still yet to recover back to their pre-crisis revenue levels. The beauty of the consumer staples sector is that they are money makers rain, hail or shine.

For most consumer staples companies, the impact of the recession was isolated to a small dip in revenues, in 2008 or 2009. Some consumer staples like McKormick and Company hardly noticed that there were recessions in 2008/2009. They actually grew their revenues through this period, and revenues for these companies have been growing every year since.

Wide Moats

Wide  moats are key to my investing. Well established consumer staples are category leaders with strong brand recognition and consumer loyalty. In fact, each passing year of market leadership just tends to further widen existing moats, bringing with it preferred store placement and deepening brand awareness and consumer recognition. This acts as a very strong repellent to emerging competition and cheaper priced competition.

In fact, given that the pricing of consumer staples tend to be a very small proportion of overall consumer disposable income, that helps keep them somewhat insulated from low priced knockoffs. This is particularly so given that many of these category of products tend to be things that are ingested, or applied to the skin. Not many folks want to take the risk of cheap knock offs on or in their bodies.

Pricing Power

Entrenched consumer staples businesses that eventually develop wide moats tend to exercise considerable pricing power. While rising commodity prices have led some staples to experience margin pressure, companies such as McCormick and Colgate still wield considerable pricing pressure.

Consider the gross margins of Colgate. They have remained solidly in the mid 50% range for the last 10 years. In fact, gross margins for Colgate have risen over this period and now hover at just under 60%. McKormick has also displayed considerable pricing power, with gross margins remaining consistently in the 40% mark over the last 10 years.

Low volatility

I have a number of small cap dividend paying stocks. While I love having these stocks in my portfolio, they move around like a yo yo as far as changes in price go. These companies sometime give me heart palpitations given the degree to which their stock prices are subject to movement. And it’s for good reason. A number of my small cap dividend paying stocks have market betas close to 2, which means the move twice as much as a general move in the market.

Your consumer staples on the otherhand?  Consumer staples beta’s tend to be incredibly low. Both Colgate and McKormick have beta’s below 0.5, meaning that move just half as much as a general movement in the market.

Downsides to consumer staples?

Changing consumer tastes

This biggest risk I foresee with a concentrated consumer staples dividend portfolio is the risk of changing consumer tastes. Consumers are a fickle group, so they may choose to switch brands readily as they latest toothpaste or bodywash hits the market. However the risk of a product category disappearing has to be considered pretty low.

The idea that we may just stop brushing our teeth or showering with soaps and body washes or eating cereals seems difficult to imagine at this juncture. So consumer staples as a category will likely have consistent, predictable demand for years to come. Unlike the technology sector, there’s little risk of category killers as such.

Regulatory

With every increasing scrutiny and research into products that are high in sugar, fat or toxins, there are always chances that regulators may discover some toxic substances in toothpastes or gels that they aren’t happy with, or start cracking down on cereals, foods or supplements that are very suggary, high in fats or high in something else.

A diversified portfolio of consumer staples across multiple categories would likely significantly cut down the risk of any catastrophic event impacting the portfolio.

Strong total returns

While consumer staples have consistent, but not spectacular demand and fairly low volatility, that does that make them poor returning or poor investments for total return?

I picked a sample of 5 of my favorite consumer staples, to see how they’ve performed over the last 10 years. My favorite consumer staples are Colgate, McKormick, Church & Dwight (which I’d love to get a piece of at some stage, but which has just been too far out of my reach), Kimberly Clark, and Proctor & Gamble.

So how would a portfolio with these names have done over 10 years? Here’s what $10k in each of these names invested 10 years ago would be worth today.

Colgate: $10k in 2004 is worth $33k today

McKormick: $10k in 2004 worth $38k today

Church & Dwight: $10k in 2004 worth $73k today

Kimberly Clark: $10k in 2004 worth $33k today

Proctor & Gamble: $10k in 2004 is worth $25k today

An equal weighted portfolio in these names with $10k in each (or $50k in total) would have returned $202k today. A 4x return!. Not bad for a set of boring staple stocks!. Church and Dwight would have accounted for a line’s share of that return, but all the other stocks performed fairly well. A similar investment in an index would be worth a touch over $100k today.

Conclusions

Conventional wisdom suggests that one’s holdings should be well diversified. There are many ways to diversify, and a concentrated holding of stocks in a specific sector is not one of these ways. However, as you’ve hopefully gathered it’s possible to achieve a consistent, stead revenue and earnings stream with consumer staples companies. Additionally, you can do all of this with a relatively low level of volatility.

Further, it’s not just a great stream of dividend income that you accumulate over time. Consumer staple companies can deliver you powerful total returns as well. Does that mean I’d concentrate a full portfolio in just this sector? Probably not, because that would mean I’d be ignoring some powerful, high returning businesses in other sectors like Visa, CME or Novartis which have been equally lucrative.

However if we are in the beginnings of a correction which takes the Dow below 15,000, you can bet that I’ll be looking to significantly increase my exposure to some of these consumer staples names.

 

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