Why You Should Own More Consumer Staple Stocks

Includes: CL, GIS, KO, KXI, PG, TAP, VDC
by: Joseph Blake

Historically, consumer staple stocks (41 out of the S&P 500) like General Mills (NYSE:GIS), Coca-Cola (NYSE:KO), Colgate-Palmolive (NYSE:CL), Molson Coors (NYSE:TAP), or Procter & Gamble (NYSE:PG) offer a long history of better returns than the S&P500 Index and less risk. They also have strong records of dividend increases. This sector is known to offer good yields and regular increases which may make them a better place to get regular income than the traditional fixed income sector. The current yields on bonds are so low that they may well have above average potential for losses when yields increase.

Consumer Staple stocks as a group sell or offer products or services we all know and understand. Consumer Staple stocks offer brands that are well known and found in every home. While companies like Google (NASDAQ:GOOG) or Apple (NASDAQ:AAPL) have dazzled investors with their returns, they require one to understand the revenue model and technology to assess their value and they do not have decades' long records of dividend payments. Their value is based on technology while consumer staple stocks are based on consumer loyalty to a brand name such as Cheerios, Crest, Band-Aid, Tide, or Kleenex. Google and Apple offer well above average returns but also well above average risk.

Consumer Staple stocks in recent years have been favored for their yields relative to bonds. In 2009 many of these stocks yielded more than 5%. Because of the very low yields available in fixed income markets, investors have bid up these stocks more than the general equity markets. The effect of quantitative easing has meant bond yields of less than 2% despite significant increase in the supply of Treasury securities. Subsequent price gains and dividend increases have meant excellent total returns for this sector. Even though yields are lower than three years ago (2.5%), they are still better than the ten-year Treasury of 1.75% and offer reasonable expectations for dividend increases better than inflation.

From 1990 through November, 2012 the total return of the Consumer Staple Index has outperformed the S&P 500 Index 10.66% versus 8.52%. The return is not only more than the index but also more than might be expected using traditional valuation models such as the Capital Asset Pricing Model. The sector has a lower beta than the index - 0.49 versus 1. In other words the investor got more return than expected but took less price risk than the market. This means less volatility.

Does this mean an investor should only buy these stocks? The diversification rule says not to do this especially because portfolios need exposure to international markets for their growth potential and currency diversification. However, their track record of above average returns and below average risk says the consumer staples sector should have a higher weighting in the portfolio. One could argue that the larger allocation to this sector could be achieved by reducing allocation to the fixed income sector or the non-consumer staple large cap stocks.

If one wanted to do this, there are several ways for small investors to do this. Vanguard offers a Consumer Staples Index fund (NYSEARCA:VDC) and there are exchange-traded funds such as iShares Global Consumers Staples ETF (NYSEARCA:KXI). These funds allow you to get diversification within the sector with relatively modest initial investments. VDC is solely domestic consumer staples stocks and KXI is global. The funds overlap and hold many of the same companies. Buying both would usually not make sense. KXI as a traded fund has no hidden tax gains or losses because your basis in the shares is what you paid for them rather than the fund's basis. VDC is part of the Vanguard family of funds which is very user friendly for small investors.

New tax changes may make dividends subject to higher taxes but many individual investors will not feel the pain of that rate and may even find a buying opportunity to get good, steady income increases.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.