Fisher Investments on Consumer Staples E-Book

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Fisher Investments Press
• Sprache: Englisch

Seitenzahl: 266

Veröffentlichungsjahr: 2009

Beschreibung

The third installment of the Fisher Investments On series is a comprehensive guide to the Consumer Staples industry--which includes companies that manufacture and sell food and beverages, tobacco, prescription drugs, and household products, to name a few. This reliable resource provides you with the tools to help you understand and analyze opportunities within today's global Consumer Staples sector. With this book as your guide, you can quickly become familiar with how the Consumer Staples sector is segmented by industries, their respective macroeconomic drivers, and the challenges facing companies in this sector. Additionally, there are chapters dedicated to explaining many of the unique aspects of Consumer Staples products in emerging markets and security analysis techniques focused on Consumer Staples firms. You don't have to be a professional to learn to better invest in the Consumer Staples sector--but you do need to be prepared. Fisher Investments on Consumer Staples can help get you up to speed in this area and help you make better decisions through any market conditions. For more information visit www. consumerstaples.fisherinvestments.com

Leseprobe

Table of Contents

FISHER INVESTMENTS PRESS

Title Page

Copyright Page

Foreword

Preface

USING YOUR CONSUMER STAPLES GUIDE

Acknowledgements

I - GETTING STARTED IN CONSUMER STAPLES

Chapter 1 - CONSUMER STAPLES BASICS

OVERVIEW

STAPLES’ DISTANT COUSIN—CONSUMER DISCRETIONARY

THE BUSINESS CYCLE’S WINDS OF CHANGE

BORING CAN BE BEAUTIFUL

Chapter 2 - HISTORY OF CONSUMERISM IN AMERICA

COLONIAL AMERICA AND CONSUMERISM

MASS PRODUCTION IN THE LATE NINETEENTH CENTURY

THE ROARING TWENTIES AND THE CONSUMER ECONOMY (1921-1929)

MASS MARKETING AND MODERN CONSUMER PRODUCTS

THE MODERN LANDSCAPE

Chapter 3 - CONSUMER STAPLES SECTOR DRIVERS

ECONOMIC DRIVERS

POLITICAL DRIVERS

SENTIMENT DRIVERS

II - NEXT STEPS: CONSUMER STAPLES DETAILS

Chapter 4 - CONSUMER STAPLES SECTOR BREAKDOWN

GLOBAL INDUSTRY CLASSIFICATION STANDARD (GICS)

GLOBAL CONSUMER STAPLES BENCHMARKS

FOOD, BEVERAGE & TOBACCO

HOUSEHOLD & PERSONAL PRODUCTS

FOOD & STAPLES RETAILERS

Chapter 5 - CHALLENGES IN THE CONSUMER STAPLES SECTOR

CHALLENGE 1: GROWING IN MATURE INDUSTRIES

CHALLENGE 2: DEALING WITH VOLATILE INPUT COSTS

Chapter 6 - CONSUMER STAPLES IN EMERGING MARKETS

OPPORTUNITY KNOCKS

EMERGING MARKETS AND CONSUMER PRODUCTS

INVESTMENT IDIOSYNCRASIES

III - THINKING LIKE A PORTFOLIO MANAGER

Chapter 7 - THE TOP-DOWN METHOD

INVESTING IS A SCIENCE

THE TOP-DOWN METHOD

TOP-DOWN DECONSTRUCTED

MANAGING AGAINST A CONSUMER STAPLES BENCHMARK

Chapter 8 - SECURITY ANALYSIS

MAKE YOUR SELECTION

A FIVE-STEP PROCESS

IMPORTANT QUESTIONS TO ASK

Chapter 9 - CONSUMERIZE YOUR PORTFOLIO—INVESTING STRATEGIES

STRATEGY 1: PLAYING THE MARKET CYCLE

STRATEGY 2: PLAYING STYLE SHIFTS

STRATEGY 3: DEVELOP NEW CATEGORIZATIONS

IMPLEMENTING YOUR STRATEGY

Appendix Consumer Staples Sector Resources

Notes

About the Authors

Index

FISHER INVESTMENTS PRESS

Fisher Investments Press brings the research, analysis, and market intelligence of Fisher Investments’ research team, headed by CEO and New York Times best-selling author Ken Fisher, to all investors. The Press covers a range of investing and market-related topics for a wide audience—from novices to enthusiasts to professionals.

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Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Fisher Investments.

Fisher Investments on consumer staples / Fisher Investments with Michael Cannivet, Andrew S. Teufel.

p. cm.—(Fisher Investments Press)

Includes bibliographical references and index.

eISBN : 978-0-470-49815-6

1. Consumer goods—United States—History. 2. Consumption (Economics)—United States—History. I. Cannivet, Michael. II. Teufel, Andrew S. III. Title.

HF1040.8.F56 2009

332.67’22—dc22

2009001913

Foreword

You’re holding the third in a series of investing guides from Fisher Investments Press—the first ever imprint from a money management firm, produced in partnership with John Wiley & Sons. These guides are your introduction to a usable, top-down strategy for analyzing standard investing sectors (Energy, Materials, Consumer Staples, Health Care, Industrials, etc.) as well as other investing regions and categories. We plan on tackling them all.

Why publish an investing series when, to my knowledge, no other money manager has done it? Simple: It’s a logical extension of standard operating procedure at my firm. We place a heavy premium on education—of our clients, of the broader world, and internally of our own employees who we work hard to promote internally. The more we teach, the more we can learn about capital markets, and the faster we can advance our own and others’ understanding of how they work. This can only make us all better investors over time.

Consumer Staples is perhaps an underappreciated sector. It’s not seen as hot and high growth—but this is a mistake. First, Consumer Staples has both growth and value areas—unusual but not unheard of for an investing sector. Second, it’s wrong to think one sector is inherently better or worse than another. Given enough time, finance theory says all investing categories should net pretty similar returns when properly accounted for—though traveling different paths. Consumer Staples is no exception.

Consumer Staples plays a key role for global, top-down investors. Because there’s generally inelastic demand for Staples goods and services, it’s historically been a defensive play. This sector tends to hold up relatively well in market downturns, while generally lagging during boom times—but not always! A good investor needs to understand when and why Staples are likelier to lead or lag. Even if you believe Staples are apt to lag, they can still diversify and be a critical counter strategy should your bullish core strategy bets go awry. You’ll read more on this in Chapter 7.

An interesting feature about Consumer Staples: Emerging markets goad demand for Staples products. (Though whether individual emerging markets emerge or submerge is a separate question entirely, one another impending Fisher Investments Press title, Fisher Investments on Emerging Markets, aims to answer.) Currently, in many less-developed economies, demand for Staples is more elastic, meaning the sector there can act more like its cousin, Consumer Discretionary. A good investor must know how and why that happens to make better, forward-looking overall forecasts. This book can teach you how.

Don’t look to this book for hot stock tips for 2010, 2011, 2018, or 2035. Any book claiming to provide them is a fairy tale. Rather, this book provides a workable, repeatable framework for increasing the likelihood of finding profitable opportunities in the Consumer Staples sector. And the good news is the investing methodology presented here works for all investing sectors and the broader market. This methodology should serve you not only this year or next, but the whole of your investing career. So good luck and enjoy the journey.

Ken Fisher CEO of Fisher Investments Author of the New York Times Best Sellers The Ten Roads to Riches and The OnlyThree Questions That Count

Preface

The Fisher Investments On series is designed to provide individual investors, students, and aspiring investment professionals the tools necessary to understand and analyze investment opportunities, primarily for investing in global stocks.

Within the framework of a top-down investment method (more on that in Chapter 7), each guide is an easily accessible primer to economic sectors, regions, or other components of the global stock market. While this guide is specifically on Consumer Staples, the basic investment methodology is applicable for analyzing any global sector, regardless of the current macroeconomic environment.

Why a top-down method? Vast evidence shows high-level, or macro, investment decisions are ultimately more important portfolio performance drivers than individual stocks. In other words, before picking stocks, investors can benefit greatly by first deciding if stocks are the best investment relative to other assets (like bonds or cash) and then choosing categories of stocks most likely to perform best on a forward-looking basis.

For example, a Technology sector stock picker in 1998 and 1999 probably saw his picks soar as investors cheered the so-called “New Economy.” However, from 2000 to 2002, he probably lost his shirt. Was he just smarter in 1998 and 1999? Did his analysis turn bad somehow? Unlikely. What mattered most was stocks in general (and especially US technology stocks) did great in the late 1990s and poorly entering the new century. In other words, a top-down perspective on the broader economy was key to navigating markets—stock picking just wasn’t as important.

Fisher Investments on Consumer Staples will help guide you in making top-down investment decisions specifically for the Consumer Staples sector. It shows how to determine optimal times to invest in Consumer Staples, what industries and sub-industries are likelier to do best, and how individual stocks can benefit in various environments. The global Consumer Staples sector is complex, including a handful of sub-industries and many countries, each with their own unique characteristics. Using our framework, you should be better equipped to critically analyze the sector, spot opportunities, and avoid major pitfalls.

This book takes a global approach to Consumer Staples investing. Most US investors typically invest the majority of their assets in domestic securities; they forget America is less than half of the world market by weight—over 50 percent of investment opportunities are outside our borders. Many of the world’s largest Consumer Staples firms are based in foreign nations, including several in emerging markets. For those domiciled on domestic soil, a large percentage of sales is often derived overseas. Simply stated, it is vital to maintain a global perspective when investing in Consumer Staples today.

USING YOUR CONSUMER STAPLES GUIDE

This guide is arranged into three sections. Part 1, “Getting Started in Consumer Staples,” discusses fundamental sector basics and Consumer Staples’ high-level drivers. Here we’ll discuss basic tenets of the Consumer Staples sector, including a detailed explanation about the economic notion of elasticity and an introduction to common strategic attributes enjoyed by successful firms operating in the sector. We will also delve into a historical survey of key transition periods that helped shape the modern Consumer Staples sector. The introductory section of the guide then finishes up with an overview of vital economic, political, and sentiment drivers of the sector.

Part 2, “Next Steps: Consumer Staples Details,” builds on the foundational knowledge from Part 1, opening the door to more granular sector analysis. We’ll take you through the global Consumer Staples sector investment universe and its diverse components. Firms operating in this sector are similar because they tend to be relatively non-economically cyclical, but diverse in scope, including manufacturers from various levels of the supply chain and retailers. We’ll take you through each industry of the sector in detail in explaining how they operate and what specifically drives each industry—so you can analyze the current operating environment and have a rational basis for choosing which industry will most likely outperform or underperform looking forward. Part 2 will also expose you to unique challenges faced by firms operating in the Consumer Staples sector and provide a detailed account of the unique state of consumer products in emerging markets.

Part 3, “Thinking Like a Portfolio Manager,” delves into a top-down investment methodology and individual security analysis. You’ll learn to ask important questions like: What are the most important elements to consider when analyzing Consumer Staples firms? What are the greatest risks and red flags? This book gives you a step-by-step process to help differentiate firms so you can identify those with the greatest probability of outperforming. We’ll also discuss a few investment strategies to help determine when and how to overweight specific sub-industries within the sector.

Note: We’ve specifically kept the strategies presented here high level so you can return to the book for guidance no matter the market conditions. But we also can’t possibly address every market scenario and how markets may change over time. And many additional considerations should be taken into account when crafting a portfolio strategy, including your own investment goals, your time horizon, and other factors unique to you. Therefore, you shouldn’t rely solely on the strategies and pointers addressed here because they won’t always apply. Rather, this book is intended to provide general guidance and help you to begin thinking critically not only about the Consumer Staples sector, but investing in general.

Further, Fisher Investments on Consumer Staples won’t give you a silver bullet for always picking the best stocks. The fact is, the right Consumer Staples stocks will be different in different climates and situations. Instead, this guide provides a framework for understanding the sector and its industries so that you can be dynamic and find information the market hasn’t yet priced in. There won’t be any stock recommendations, target prices, or even a suggestion whether now is a good time to be invested in the sector. The goal is to provide you with tools to make these decisions for yourself, now and in the future. Ultimately, our aim is to give you the framework for repeated, successful investing.

Acknowledgments

No book is ever the product of just one or two people, and we extend our sincere gratitude to a number of colleagues and business associates for their help in making this book a reality.

First, we thank Ken Fisher for providing this wonderful opportunity. There are also a number of Fisher Investments colleagues instrumental to this project, each deserving of praise and thanks. First, a big thank you to Nader Farzan, who helped produce most of the graphs you will find in this book. We also owe special thanks to Michael Hanson and Lara Hoffmans, whose patient mentoring and editing were integral in bringing this book from the idea stage to completion. Dina Ezzat deserves praise for helping manage the on-time delivery of the book, while also offering much appreciated assistance with source citations. Evelyn Chea helped put the finishing touches on the book by offering her editorial expertise. Leila Amiri brought valuable graphic design contributions in coming up with the graphics that appear in the book. Michael Sanberg and Tom Holmes particularly assisted Michael Cannivet in helping carry out his full-time research responsibilities while he was working on the book. Special thanks also go to the team that brought Fisher Investments Press to life—Marc Haberman, Molly Lienesch, and Fabrizio Ornani.

Of course this book would also not be possible without our data vendors, so we owe a debt of gratitude to Thomson Datastream, Thomson Reuters, and Global Financial Data in particular for their permissions. We’d also like to extend our appreciation to our team at Wiley for their support and guidance throughout this project, especially David Pugh and Kelly O’Connor.

Last, Michael would also like to thank his wife Jennifer, who edited the first copies of this book in their earliest form and probably learned more about the Consumer Staples sector than she ever bargained for in the process. This book could not have been completed without her unwavering love and support.

I

GETTING STARTED IN CONSUMER STAPLES

1

CONSUMER STAPLES BASICS

Joe Consumer has one thing on his mind at 6:10 Monday morning: Coffee. Lulled by the drip of the coffeemaker, Joe idly listens to the news. After his first cup, Joe pours himself some Wheaties—the “Breakfast of Champions.” He stares at the bright orange box, recalling childhood dreams of becoming the next athlete to grace the front. Waking from his nostalgia, Joe quickly showers and shaves. He’s chagrined to discover he’s out of deodorant—his wife’s deodorant is the only alternative. (Hopefully, they mean it when they say “strong enough for a man.”) Next, he brushes his teeth but is bothered by his reflection—his hair is paying homage to Alfalfa. He gels his cowlick and is out the door 10 minutes behind schedule, as usual.

Your morning routine may be similar to Joe’s. The day-to-day items you use and the investment potential inherent in these products are the focus of this book. Coffee manufacturers, food and toothpaste firms, and a host of other businesses all fit into the global Consumer Staples sector.

This book casts a spotlight on the countless investment ideas found in the myriad products you have in your kitchen, bathroom, and workplace. Of the 10 standard investing sectors, Consumer Staples arguably plays the most active role in daily life. Many of the firms making the products you use daily are publicly traded and can be an integral part of your portfolio.

This chapter will highlight some Consumer Staples basics, including what makes some consumer products staples and others discretionary—particularly focusing on the concept of elasticity. We’ll also view long-term sector performance trends and analyze a very famous investor’s take on Consumer Staples stocks.

OVERVIEW

Each investing sector has a unique set of attributes. The Industrials sector, for example, is generally capital intensive and economically sensitive. The Energy sector is highly dependent on the supply and demand for oil, while the Technology sector is innovation driven, with a degree of economic cyclicality. So what characterizes the Consumer Staples sector?

Some common characteristics: First, this sector’s products have a common end market—consumers. Second, like Joe Consumer, these are products many folks use daily. Finally, frequency of use tends to be consistent for these products, regardless of how the economy is doing.

Note: This isn’t to say Consumer Staples is inherently superior to other sectors—it isn’t. But Consumer Staples, like each sector, has unique attributes leading both to outperformance and underperformance depending on economic and market conditions. There will be periods when Consumer Staples performs very well relative to the broad market and periods when it lags. The aim of this book is to give you tools to help better predict when that happens and why.

A Big Target Market

Relative to some other standard investing sectors, Consumer Staples has a huge target market. Consumer spending represents about 70 percent of the US’s gross domestic product (GDP), as shown in Figure 1.1. It’s tough to get a much larger target market than selling directly to consumers.

Figure 1.1GDP Composition Breakdown

Source: US Department of Commerce Bureau of Economic Analysis.

Not only do Consumer Staples firms have vast potential target markets, but the goods they produce can be ubiquitous. Staples products are nearly everywhere—home, work, stores, restaurants, and so on. Purchasing these items is a natural routine of most grocery store trips and can be an automatic decision based on brand familiarity. Finally, consumption patterns for staples—which are generally viewed as basic necessities—tend to be recession resistant and more stable over time relative to other standard investing sectors.

Sector Composition

Consumer Staples can be broken down into three main categories: Food, Beverage & Tobacco (grouped as one category); Household & Personal Products; and Food & Staples Retailers. (Chapter 4 will cover each of these industries and sub-industries in greater detail.) Table 1.1 lists just a few familiar firms and some of their best-known brands, and the 10 largest global Staples firms (by market cap) are listed in Table 1.2.

Table 1.1Examples of Companies & Products by Industry

Table 1.2Top 10 Consumer Staples Firms

Source: Thomson Datastream; MSCI, Inc.1 as of 06/30/2008.

STAPLES’ DISTANT COUSIN—CONSUMER DISCRETIONARY

Consumer Staples and Consumer Discretionary are a little like cousins—part of the same general family (consumer oriented), but not much in common beyond that.

Consumer Discretionary firms include automobile manufacturers like General Motors, apparel stores like Gap, national restaurant chains like the Cheesecake Factory, and large entertainment firms like Disney. The primary difference between the two sectors is Staples firms produce goods deemed as necessities (soap, cereal, bottled water), while Discretionary firms produce goods deemed as non-necessities (cars, clothing, laptops). This difference can be examined more critically by comparing them in terms of elasticity.

Elasticity

Elasticity is a measure of one variable’s sensitivity to a change in another variable. The term references changes in demand relative to changes in price or income. The concept of elasticity is core to understanding what makes the Consumer Staples sector tick.

Elasticity can be calculated two basic ways:

If elasticity is greater than or equal to 1 in either calculation, then the demand curve is considered elastic. If it is less than 1, it’s inelastic.

Consumer Staples products are inelastic—necessities purchased by consumers regardless of how their personal economic situation shifts over time. Discretionary products are just the opposite—elastic—since income or price fluctuations do materially impact consumer demand.

Income Elasticity How can income and price elasticity drive buying decisions? Back to our friend, Joe Consumer. Joe just got a promotion and a 20 percent increase to his current salary of $70,000 a year. Joe is excited—instead of just one annual family vacation, he figures they can now afford two per year. Here’s how the elasticity of Joe’s travel mathematically works out, using the income elasticity equation:

With an elasticity of 5, Joe’s travel is highly elastic—like most of the broad population. This means that during strong economic times, when many people see wage increases, travel in general shoots up, positively influencing hotels, rental car firms, and so on. Note these are all Consumer Discretionary industries.

Now let’s look at how this raise impacts another aspect of Joe’s life—his soda consumption. Joe usually drinks a six-pack of Coke per week. He doesn’t suddenly start drinking twice the number of Cokes just because he got a raise. A six-pack per week is still fine. Here’s how the income elasticity calculation works in this instance:

With an elasticity calculation of zero in this example, Coke (a Consumer Staples product) has an inelastic demand relationship to Joe’s income.

Note that most investors are unlikely to run elasticity calculations like this in their day-to-day analysis. Nevertheless, the example serves as a practical demonstration of what makes some goods more elastic than others.

Price Elasticity Price elasticity plays a similar role to income elasticity. A price increase will act as a demand deterrent to consumers of discretionary products because as the price of the product escalates, so does the opportunity cost of buying the product. (Opportunity cost is what you give up to get what you want, whether it’s time, money, etc.)

An example of price elasticity in relation to a discretionary product: What happens to Joe’s vacation plans if energy costs spike? One obvious result—he must pay more for his family’s airfares. Consequently, he may postpone his family trip until prices drop a bit or he might take a cheaper vacation than originally planned.

How does price elasticity figure in relation to one of Joe’s favorite Consumer Staples items—Coca-Cola? Increased energy costs affect this too. Since Coke now has to pay more to distribute its products, it will likely raise its prices, just like the airlines. Dollar-wise, however, this price increase has a much smaller impact on Joe’s overall budget, so he’ll probably keep drinking the same number of Cokes every week.

Elasticity From an Investment Standpoint These examples underscore why Consumer Staples stocks can perform better relatively during tumultuous economic periods: When the economy contracts, wages can come under pressure, diminishing demand for many goods. Inflation is another phenomenon that can impact prices—if prices rise faster than wages can keep pace, demand can decrease.

Both of these have the power to materially diminish demand for products across most sectors (not just Consumer Discretionary). But historically, demand holds up relatively well in the Consumer Staples sector. For this reason, investors often seek “safe haven” here. While sales or earnings might not expand much in an economic downturn, the relative price to earnings (P/E) multiple of the sector often rises as investors begin to place more of a premium on earnings consistency. (We will cover this phenomenon in greater detail later.)

Price Elasticity of Demand

The price elasticity of demand is influenced by three primary determinants.

1. Price relative to income. If the price of an item is high in proportion to one’s income, then price changes will be important.

Example: Airline travel and new cars are expensive, so even a small percentage change in their prices can have a big impact on a consumer’s budget and consumption patterns. Shampoo, however, is a small percentage of the average consumer’s income; hence, it tends to be price inelastic.

2. Availability of substitutes. The greater the number of substitute products, the more elastic goods tend to be.

Example: Fish is fairly elastic since consumers can always eat more beef, chicken, or pork if fish prices rise sharply. Cigarettes, however, are fairly inelastic, since most smokers can’t imagine any other product that could easily substitute for a cigarette.

3. Time. When consumers have more time to adjust their consumption patterns, price elasticity tends to increase.

Example: The quantity of gasoline demanded doesn’t immediately fall much when gasoline prices rise, since consumers cannot easily trade in their current vehicle for a more fuel efficient one. However, if gas prices stay high for a number of years, this tendency slowly begins to change, because with more time, consumers are better able to adjust their consumption habits. Therefore, the long-run price elasticity of demand is higher than short-run elasticity.mix

THE BUSINESS CYCLE’S WINDS OF CHANGE

We’ve discussed the different levels of economic sensitivity when comparing the Consumer Staples sector to Consumer Discretionary and how this can favor Staples firms in a slower economy. Now let’s touch on how economic seasonality can work against the Staples sector.

In a robust economy, Staples firms are at a disadvantage relative to other sectors because they find top-line sales growth harder to come by. Further, profit margins in several of the Staples industries can be thinner compared to Discretionary firms. Based on these differences, Consumer Discretionary stocks can bring more portfolio upside if the economy is expected to be rosy, since sales and profits can ramp up in a hurry for many of these firms. Staples firms, on the other hand, tend to maintain their steady pace. During strengthening economic periods, investors typically shift away from the Consumer Staples sector and place a higher premium on sectors leveraged to economic upside.

P/E versus P/E

The average P/E ratio of the Consumer Staples sector over the last 10 years (1998-2007) is 22.4, whereas Discretionary traded at 26.0 times trailing earnings.

Table 1.3 shows that out of the 10 years there were three years where Consumer Staples traded at a higher multiple than Consumer Discretionary: 1998, 2000, and 2007. 1998 saw a massive stock market correction and both 2000 and 2007 marked the beginning of bear markets.

Table 1.3Consumer Discretionary vs. Consumer Staples P/E Comparison

Source: Thomson Datastream; MSCI, Inc.2

Wal-Mart’s Fashion Foray

“If at first you don’t succeed, try, try again”—a good summary of Wal-Mart’s continual attempts to penetrate the higher-value apparel market. In 2006, Wal-Mart placed expensive ads in Vogue and debuted new apparel offerings at New York’s Fashion Week. However, the company soon discovered that core Wal-Mart shoppers were no fashionistas and were unwilling to pay big bucks for designer clothing. Sales were weak and overstocked inventories became a drag on earnings.

Despite this setback, Wal-Mart was at it again two years later—trying to intertwine more expensive clothing into its discount-oriented stores. The new message emphasizes both fashion and quality at an affordable price. Why the persistence? Apparel remains attractive to Wal-Mart because as the company builds fewer stores, it must generate more profits from existing stores. Discretionary products like high-end clothing have higher profit margins than traditional Wal-Mart merchandise, which includes an assortment of Staples items. The clothing line profit margins are estimated to be about 31 percent—a full 10 percentage points ahead of all the other categories the discounter sells.

Source: Ann Zimmerman and Cheryl Lu-Lien Tan, “After Misstep, Wal-Mart Revisits Fashion,” Wall Street Journal (April 24, 2008).

Staples Stock Performance Versus Discretionary

Given what we now know about how different the Consumer Staples and Consumer Discretionary sectors are, how do you think their stock performances stack up? Figure 1.2 provides a snapshot over the last 10 years, using the MSCI World Index as a proxy.

There are a couple noteworthy periods:

1. From mid-1998 to the end of 1999, Discretionary trounced Staples in relative performance.

2. As the bear market ensued in 2000, Discretionary sold off precipitously while Staples gained ground.

3. Discretionary bounced more sharply when the next bull market came to life, rising at a faster pace than Staples through 2003.

4. Staples and Discretionary both rallied as the bull market progressed over the next couple years, with Discretionary maintaining a slight lead.

Figure 1.2MSCI Consumer Staples Sector vs. Discretionary Over the Last 10 Years

Source: Thomson Datastream; MSCI, Inc.3

The next big divergence happened in late 2007, when the recent bear market started. Discretionary fell much more sharply than Staples through the first two quarters of 2008 (Figure 1.2 stops at 7/1/008).

Now let’s break open the anatomy behind what can drive share price performance differentials by looking at price movement, earnings-per-share (EPS) growth, and relative P/E multiple expansion and contraction between the two sectors. For the purposes of this exercise, we’ll look at the period of 6/30/2007 to 6/30/2008.

Table 1.4 shows MSCI World Consumer Discretionary and Consumer Staples cumulative monthly returns as the bear market began to take shape in late 2007.

Discretionary stocks sold off close to 10 percent by the end of 2007. Meanwhile, Staples rallied. By the time the first half of 2008 concluded, Discretionary had fallen 25.4 percent, compared to a modest Staples decline of 3.4 percent.

Table 1.4MSCI World Consumer Discretionary vs. Consumer Staples (6/30/2007-6/30/2008)

Source: Thomson Datastream; MSCI, Inc.4

What drove this vast performance differential? During times of distress and particularly during bear markets, investors place a premium on the earnings consistency of Consumer Staples stocks. Between 6/30/2007 and 6/30/2008, as the world economy began slowing, both sectors were able to continue growing their earnings (although Consumer Staples grew at a stronger pace). The MSCI World Consumer Staples constituent universe grew its EPS by 15.1 percent, while the MSCI World Consumer Discretionary universe grew its EPS by 12.0 percent.

Along the way, valuations began changing. Investors became willing to pay less for both sectors’ earnings as their outlook deteriorated and risk aversion heightened. During the 12-month period, the P/E ratio for Staples fell from 20.0 on 6/30/2007 to 16.6 on 6/30/2008 (a 17 percent decline). Consumer Discretionary, however, saw far more severe multiple contraction while investors were fleeing for safety, with the sector’s P/E falling from 22.6 to 13.8 (a 39 percent decline).

It’s important to remember that earnings and valuation are both determinants of price performance. Table 1.5 breaks down the anatomy of the two sectors’ price performances over the period.

Table 1.5Anatomy of Price Performance—CS vs. CD (6/30/2007-6/30/2008)

Source: Thomson Datastream; MSCI, Inc.5

BORING CAN BE BEAUTIFUL