Value And Quality Stocks In Consumer Staples

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Includes: ABEV, AGRO, AVP, BORN, CAG, CCE-OLD, CHD, CPB, ELF, ENR, EPC, GIS, HLF, HSY, IBA, IMKTA, INGR, JBSS, K, KMB, KR, MDLZ, MO, MTEX, NEPT, NHTC, NUS, PFGC, PM, PME, POST, PPC, SAFM, SDI, SFM, SJM, SPB, SYY, TAP, TPB, TSN, TWNK, TYHT, UNFI, USFD, USNA, WBA, WILC, WMT, XLP
by: Andres Cardenal, CFA
Summary

Successful investing does not need to be too complicated, it all comes down to buying solid businesses for a convenient valuation.

Introducing a quantitative system focused on financial quality and valuation in the consumer staples sector.

Backtested performance is quite encouraging.

A system such as this one can be a valuable tool to make smart investing decisions by focusing on hard quantified data as opposed to subjective opinions and speculation.

The consumer staples sector is home to many high quality companies with strong fundamentals and renowned brands. On the other hand, the industry is also very competitive, and it’s not easy for companies in the sector to find new opportunities for growth in mature and crowded markets for many consumer staples products.

In order to find the best stocks in the consumer staples sector, the following paragraphs will be introducing a quantitative system based on financial quality and valuation.

The numbers alone don't really tell you everything you need to know to make an investment decision, it's important to understand the business behind those numbers in order to build a complete investment thesis. That acknowledged, quantitative systems such as this one can be enormously valuable tools to identify investment ideas with attractive potential for further research.

Quality And Value By The Numbers

The quantitative system is based on a ranking algorithm; this is essentially different from a screener. A screening system will invest only in companies that meet a specific parameter - for example, the return on assets ratio is over 5% and the price to earnings ratio is below 25.

A ranking system, on the other hand, will rank companies in a particular universe based on return on assets and price to earnings ratio, and will invest in the companies with the higher ranking based on an average of those two indicators. This particular algorithm is basically an average of two main factors: quality and value.

The quality factor is a combination of metrics that includes long term growth expectations, gross profit margin, free cash flow margin, return on investment and return on equity. All else the same, it's easy to understand why companies with high profitability levels and growth expectations should deliver superior returns over time.

The value component of the ranking system includes valuation metrics such as price to earnings, price to earnings growth, price to free cash flow, and enterprise value to EBITDA. This intentionally leaves aside the dividend yield, which is one of the most popular valuation metrics among investors in consumer staples.

Dividends say a lot about a company and its financial health, and there is plenty of statistical evidence showing that companies with elevated cash distributions tend to generate above-average returns for investors. On the other hand, companies with attractive growth prospects many times tend to reinvest their cash flows as opposed to distributing that money to investors. In order to avoid penalizing companies that reinvest most of their cash flows, dividend yield is not included in this particular system.

Summing up, the ranking system uses a combination of ratios and indicators to measure both quality and value, and then it builds a final “quality and value” ranking which is an average of those two factors. The theoretical portfolio is then allocated to the companies that have the best “quality and value” ranking in a particular selection universe.

Leaving the mathematical considerations aside, it’s important to understand the simple rationality behind this quantitative system. In the words of Warren Buffett: “Price is what you pay and value is what you get”. The system uses multiple metrics to select companies based on both quality and valuation. In a nutshell, we are trying to get as much value as possible for a comparatively low price.

Backtested Performance And Portfolio Recommendations

The backtest portfolio builds an equally weighted and monthly rebalanced portfolio with the 50 stocks with the highest quality and value scores in the consumer staples sector. The portfolio is assumed to have an annual expense ratio of 1% to account for trading expenses and similar considerations, and the benchmark is the Consumer Staples Select Sector SPDR ETF (XLP).

The backtested performance numbers are quite encouraging. Since January of 1999, an investor following the portfolio recommendations from the quantitative system would have obtained an average annual return of 18.51%, far surpassing the 5.76% annual return produced by the benchmark in the same period.

Data from S&P Global via Portfolio123

In other words, a $100,000 investment in the Consumer Staples Select Sector SPDR ETF in January of 1999 would currently be worth around $298,300, and the same amount of capital allocated to the portfolio recommended by the quantitative system would have a much larger value of $2.7 million.

The table below shows the 50 names currently selected by the system, ordered by market capitalization. The table also shows forward price to earnings, price to free cash flow, and return on assets ratios to provide a quick reference about valuation and profitability levels for these companies.

Name

MktCap

Fwd PE

P/FCF

ROA%TTM

Walmart Inc (WMT)

$249,389

17.58

20.68

4.43

Philip Morris International (PM)

$127,870

15.85

100.89

15.06

Altria Group (MO)

$110,391

14.58

N/A

23.79

Ambev SA (ABEV)

$73,086

19.91

51.24

9.04

Walgreens Boots Alliance (WBA)

$62,820

10.59

15.03

5.98

Mondelez International (MDLZ)

$62,734

17.33

47.96

5.1

Kimberly-Clark Corp (KMB)

$37,355

15.55

41.63

12.03

Sysco Corp (SYY)

$36,130

23.01

39.86

7.04

General Mills (GIS)

$26,713

14.74

24.78

8.13

Kellogg (K)

$24,925

16.13

59.66

9.03

Tyson Foods (TSN)

$24,634

10.25

20.36

11

Kroger Co. (KR)

$23,180

13.75

87.98

10.03

Hershey (HSY)

$20,003

17.93

36.82

15.91

Coca-Cola European Partners (CCE-OLD)

$19,776

15.2

38.21

3.9

Molson Coors Brewing (TAP)

$15,240

14.46

11.6

4.96

Conagra Brands (CAG)

$14,060

15.95

39.23

7.75

Church & Dwight (CHD)

$13,364

24.09

29.81

14.76

J.M. Smucker (SJM)

$12,691

13.22

23.26

8.65

Campbell Soup (CPB)

$12,615

14.71

24.69

4.41

Herbalife Nutrition (HLF)

$8,900

19.58

16.85

6.46

US Foods Holding (USFD)

$8,301

18.64

13.68

5.28

Ingredion (INGR)

$8,079

14.13

18.25

9.09

Post Holdings (POST)

$5,882

20.33

14.74

3.03

Pilgrim's Pride (PPC)

$5,062

7.17

11.55

14.91

Spectrum Brands Holdings (SPB)

$4,808

23.78

20.94

3.97

Nu Skin Enterprises (NUS)

$4,393

20.54

30.15

8.41

Energizer Holdings (ENR)

$3,873

19.28

28.26

7.27

Performance Food Group (PFGC)

$3,850

23.39

17.59

4.55

Nomad Foods (MOMD)

$3,361

14.08

15.49

3.46

Industrias Bachoco SAB De CV (IBA)

$3,041

13.66

16.49

11.21

Sprouts Farmers Market (SFM)

$3,016

18.29

26.85

11.44

USANA Health Sciences (USNA)

$2,802

25.66

21.94

13.78

Edgewell Personal (EPC)

$2,801

14.99

9.24

-0.5

Sanderson Farms (SAFM)

$2,473

15.14

26.24

17.15

United Natural Foods (UNFI)

$2,154

13.31

129.31

5.73

Hostess Brands (TWNK)

$1,410

20.66

10.64

7.94

Adecoagro SA (AGRO)

$978

9.92

26.07

0.74

John B. Sanfilippo & Son (JBSS)

$882

24.6

29.4

8

e.l.f. Beauty (ELF)

$792

27.7

27.51

7.95

Avon Products (AVP)

$724

11.86

4.86

1.08

Ingles Markets (IMKTA)

$667

11.96

N/A

4.91

Turning Point Brands (TPB)

$638

17.57

17.42

7.53

Natural Health Trends (NHTC)

$289

N/A

28.63

13.7

Standard Diversified (SDI)

$242

N/A

10.59

6.47

Neptune Technologies & Bioresources (NEPT)

$235

N/A

N/A

17.76

Pingtan Marine Enterprise (PME)

$221

2.94

14.31

9.84

G. Willi Food International (WILC)

$90

N/A

5.5

6.44

Mannatech (MTEX)

$52

N/A

6.34

-1.06

Shineco (TYHT)

$39

N/A

9.58

15.18

China New Borun (BORN)

$31

N/A

1.47

5.75

It’s important to analyze the business behind the numbers before making any investment decisions. Only because a company is selected by the system, that doesn't mean that it will necessarily outperform the market going forward, and it certainly does not guarantee that the stock fits your own risk tolerance and overall investing strategy. Nevertheless, a quantitative system such as this one can be a valuable tool to identify attractive investment ideas with market-beating potential in the long term.

Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.