The Consumer Staples sector consists of companies that provide essential products. In other words, Consumer Staples are products that people cannot or are unwilling to do without. As a result of the essential nature of Consumer Staples, there are several attributes that distinguish this sector from most others. First of all, the essential nature of the products that Consumer Staples’ companies produce, are for the most part, non-cyclical. Second, Consumer Staples tend to be very insensitive to economic cycles. Therefore, their businesses tend to remain strong and healthy even during recessions.
Because of the stability and consistency that many Consumer Staple companies possess, you will find many of the bluest of blue-chip companies within this sector. However, finding these blue-chips at attractive valuations is often difficult or rare. The best-of-breed Consumer Staples companies often command quality premiums relative to companies in other sectors with equivalent fundamental attributes. To state this more simply, moderate overvaluation relative to intrinsic value based on cash flows and earnings is very common for companies in this sector.
Since I am such a stickler for valuation, I am not willing to pay more for even the best company than I believe it is worth, based on fundamental values. Consequently, several of the best-of-breed Consumer Staples companies were cut from my list based solely on valuation. To be clear, many of these stocks are currently trading at historical normal valuations, but above what I would consider to be their intrinsic value. Since this moderate overvaluation tends to be the norm with these companies rather than the exception, some prospective investors might be willing to pay the premiums for many of these names, but not me.
The dividend stalwarts that I’ve excluded based on what I’ve stated above are listed in alphabetical order as follows: Colgate-Palmolive Company (NYSE:CL), The Clorox Co (NYSE:CLX), Campbell Soup Company (NYSE:CPB), Flowers Foods, Inc. (NYSE:FLO), General Mills, Inc. (NYSE:GIS), Kimberly Clark Corp (NYSE:KMB), The Coca-Cola Company (NYSE:KO), PepsiCo, Inc. (NYSE:PEP), The Procter & Gamble Company (NYSE:PG) Reynolds American, Inc. (NYSE:RAI), The J.M. Smucker Company (NYSE:SJM), SYSCO Corporation (NYSE:SYY), Unilever plc (NYSE:UL) and Unilever N.V. (NYSE:UN).
To be clear, most of the names cited above are currently trading at historically normal premium valuations. Consequently, I consider them overvalued, and therefore, they were excluded. Another interpretation can simply be that these are quality blue-chips worthy of the premium valuations that the market is currently awarding their shares. In other words, all of the names cited above could be included as retirement portfolio candidates for the prudent dividend growth investor willing to pay a premium price for quality.
Procter & Gamble: A Classic Example of Premium Valuation
The following earnings and price coerelated graph on Procter & Gamble illustrates how the market tends to price this blue-chip at a premium. The orange line on the graph represents an fair value earnings justified PE ratio of 15, and the dark blue line represents the historical normal PE ratio of 19.5 that the market has typically valued Procter & Gamble at.
Furthermore, we see that the Great Recession of 2008 did bring Procter & Gamble’s price down to its earnings justified level and stayed there through much of 2012. However, with the bull run in 2013, Procter & Gamble’s share price has now returned to its historical normal PE ratio. Consequently, it could be argued that buying Procter & Gamble today at its historical normal PE makes a certain amount of sense. Even though the price was adjusted downward during the recession, it has since moved back into alignment with its historical normal value. However, I have never been able to make myself pay more for a company than I believe it is worth. For disclosure, I bought Procter & Gamble after it reverted to the mean, and still hold it currently.
The following estimated earnings and return calculator defaults to valuing Procter & Gamble based on the consensus of 27 analysts forecasting 5-year earnings growth at 9% (the dark orange line). However, utilizing the PE overlay feature of FAST Graphs™, I have included the historical normal PE ratio of 19.5. In other words, based on estimates that are consistent with Procter & Gamble’s historical growth, it would be fairly valued based on its historical normal PE, but overvalued based on my definition of True Worth™.
The Consumer Staples Sector
This is the sixth in a series of articles designed to find value in today's stock market environment. However, it is the fifth of 10 articles covering the 10 major general sectors. In my first article I laid the foundation that represents the two primary underlying ideas supporting the need to publish such a treatise. First and foremost, that it is not a stock market; rather it is a market of stocks. Second, that regardless of the level of the general market, there will always be overvalued, undervalued and fairly valued individual stocks to be found.