Building a Model Income Portfolio Sector by Sector: Part 2 - Consumer Staples

by: Clay King

In my first article in our series of building a dividend growth portfolio sector by sector consumer discretionary stocks was discussed. Continuing the sector theme this week I will analyze the consumer staples group, which manufacture and market consumer goods. Examples of consumer goods are clothing, food, soap, beverages, tobacco, drug retail, and paper products.

Consumer staples companies have proven to be one of the most stable and steady income producing securities for investors. Companies such as Procter & Gamble (NYSE:PG), Coke-Cola (NYSE:KO), and Clorox (NYSE:CLX) are widely held by investors seeking income, as well as growth of their principal. It is not uncommon for long term holders of these stocks to have the yearly distribution of the dividend be in excess of their cost basis.

Each sector will generally move in tandem with the others, but with different percentage swings in price. Examining the records of the different groups over a 20 year period best illustrates the varying correlations of each sector. Over the past 20 years the S&P 500, measured over rolling 1 year returns, has a performance variance between +50% to -44% with an average return of 8%. The consumer staple group has ranged from +44% to -25% with an average return of 8.5%. Over this period not only has this group returned a higher return, but has accomplished it with less volatility. This is a sector worthy of serious consideration by all dividend growth investors.

Our goal is to screen and suggest a list of high quality stocks for each sector in building our model portfolio. The database used for the screen is the 1500 stocks that make up the S&P 500 index, the 500 stocks of the mid-cap index, and the 600 stocks in the small-cap index. The sectors and current weightings are:

Consumer Discretionary 10.7%
Consumer Staples 10.7%
Energy 12.6%
Financial 15.0%
Heath Care 11.9%
Industrials 11.2%
Information Technology 17.7%
Materials 3.6%
Utilities 3.4%
Telecom Services 3.1%

We began our search for dividend growth stocks in the consumer staple sector by screening for yields above 2.5%, a five year dividend growth rate above 5%, and a payout ratio less than 60%. This criteria produced 20 stocks which we further reduced by eliminating those that had not increased the dividend each year for the previous five years. Fourteen securities remained, which are outlined in the table below:

Security Cur. Yield Div.Five Yr. Growth Rate Payout Ratio Est. EPS Growth Rate Yld Relative to 10 Yr. Median** PE Relative to 10 Yr.Median***
Colgate-Palmolive (NYSE:CL) 2.6% 12% 45% 10% 1.3 .9
Pepisco (NYSE:PEP) 2.9% 11% 48% 8% 1.6 .8
Clorox (CLX) 3.5% 14% 58% 10% 1.7 .9
Coca-Cola (KO)
2.8% 9% 51% 9% 1.1 1.0
Kimberly-Clark (NYSE:KMB) 4.2% 7% 59% 7% 1.4 .9
Procter & Gamble (PG) 3.3% 11% 52% 10% 1.7 .9
Kellogg (NYSE:K) 2.9% 8% 51% 8% 1.1 .9
Heinz (HNZ) 2.7% 6% 60% 7% 1.0 1.1
Wal-Mart (NYSE:WMT) 2.7% 14% 35% 10% 2.1 .7
General Mills (NYSE:GIS) 3.3% 11% 46% 8% 1.3 .9
Sysco (NYSE:SYY) 3.3% 9% 54% 5% 1.7 .7
Avon Products (NYSE:AVP) 3.3% 6% 49% 12% 1.7 .7
Flowers Foods (NYSE:FLO) 2.7% 12% 53% 8% 1.0 1.0
Campbell Soup (NYSE:CPB) 3.35% 5% 47% 6% 1.4 .8

** Higher number means yield is higher than 10 year median, ie. 1.1 means the yield is 10% higher than 10 year median.
*** Lower number shows PE is less than 10 year median, ie. .9 means PE is 90% of ten year median.

There are few investors who would purchase all of the stocks listed to represent only 10.7% of their portfolio. Screens do an excellent job of identifying a good list of potential candidates for possible purchase, thereby creating a watch list. If one is trying to build a buy-and-hold dividend growth portfolio without regard for current valuations, then selecting 2-4 of these stocks will serve our purpose of building a portfolio. I narrowed this list down to a small group with excellent past records and future prospects. Our top five:

  1. Procter & Gamble (PG): The company provides consumer packaged goods in a world-wide distribution network. Key brands include Gillette, Crest, Tide & Gain soap, Pampers and Charmin paper products. The Procter & Gamble Company, headquartered in Cincinnati Ohio, was founded in 1837.
  2. Coca-Cola (KO): The Company manufactures and markets beverage concentrates and syrups worldwide. Principle brands are Coca-Cola, Diet Coke, Fanta, and Sprite. Founded in 1886, the company is headquartered in Atlanta, Ga.
  3. Wal-Mart (WMT): The company operates discount retail stores world-wide. Best known for the Wal-Mart super stores, it also operates Sam's Club and Member's Mark. The company was founded in 1945 and is headquartered in Bentonville, Arkansas
  4. Clorox (CLX): The company operates in four divisions of consumer products: Cleaning, Lifestyle, Household, and International. Key brands are Clorox, Pine Sol, Formula 409, Kingsford Charcoal, and Armor All. The company was founded in 1913 and is headquartered in Oakland, Ca.
  5. Colgate-Palmolive (CL): The company manufactures and distributes consumer products world-wide. Key brands include toothpaste under the Colgate brand, Irish Spring soap, Speed Stick, and Mennen. The company was founded in 1806 and is headquartered in New York, New York.

I think that any investor buying these five stocks will be richly rewarded over any long term period. Over the last five years ending 6/30/2011, an equal weighted portfolio of these five stocks returned 45.2% compared to the S&P 500 return of only 4%. If these were owned during the bear market from September of 2007 to March of 2009 the return was a minus 6.9% versus a return of -45.8% for the S&P 500. In both cases the volatility of our five stocks was less than the market. Calculations from

The two stocks that I view in the best buying zones are Wal-Mart and Procter & Gamble. Both possess values better than their 10 year ranges and with excellent estimates for future growth.

Disclosure: I am long WMT, HNZ, PG.