Don't Typecast Consumer Stocks


Don't typecast consumer stocks

Conventional wisdom says you buy consumer-staples stocks for safety and income and consumer-discretionary stocks for growth. But in recent years, the sectors have exhibited unconventional behavior.

The S&P 1500 Consumer Staples Sector Index has delivered a total return of 554% since the end of 1994, versus 427% for the Consumer Discretionary Sector. The performance gap didn't stem from just a few periods when defensive stocks were in favor. Staples outperformed discretionary from 1995 through 2000 — a period of mostly strong market returns — as well as from 2007 through the present, which encompassed both bear and bull markets.

Consumer-staples stocks have justified their reputation as defensive investments. In rolling 12-month periods since the end of 1994, the staples sector index averaged a return of 1% during periods when the broader S&P 1500 Index was down. Staples stocks outperformed when the S&P 1500 returned less than 10% and underperformed during stronger years. But the consistent strength has resulted in market-beating returns since 1994. The discretionary sector, in contrast, has performed roughly in line with the broader index.

Can consumer-staples stocks keep up the outperformance? With consumer-discretionary names outperforming over the past year, many question whether consumer-staples stocks have seen their best days. Stocks in both sectors earn fairly similar Quadrix Overall scores, and they've managed comparable sales and profit growth over the last year. Staples stocks average lower Value scores. But the big difference is expected growth. On average, discretionary stocks are expected to deliver profit growth of 11% this year and 19% next year, versus 7% and 14%, respectively, for staples.

Keep in mind that sector comparisons don't tell the whole story in far-flung sectors such as consumer discretionary. We see plenty of discretionary stocks with appeal. Consumer-staples stocks account for 10% of the S&P 1500's market capitalization, while consumer-discretionary stocks make up 13%. Both our Buy List and our Long-Term Buy List overweight consumer discretionary relative to the market (at least 17% of the portfolio) and underweight consumer staples (no more than 8%).

Over the last year, DirecTV's ($62; DTV) sales rose 8% and earnings per share 36%, versus the average of 7% sales growth and 11% profit growth for S&P 1500 consumer-discretionary stocks. DirecTV is expected to grow per-share profits 11% this year, despite some turbulence in Latin America. Currency devaluation reduced profits in the March quarter and could remain a drag on results.

Shares remain attractively valued at 13 times trailing earnings, a 25% discount to their five-year median and 34% below the median for S&P 1500 consumer-discretionary stocks. The average discretionary stock trades at a 22% premium to its five-year median P/E ratio and 33% above historical norms for price/sales, while DirecTV trades at a discount of more than 7% based on both ratios.

Stock buybacks have sliced 59% from DirecTV's share count since the end of 2005, more than any other company in the S&P 500 index.The company has gotten a great deal on those buybacks, paying an average price of $31.60 per share. DirecTV is a Focus List Buy and a Long-Term Buy.

Kroger ($37; KR) said both store traffic and transaction size rose in the April quarter, indicating it has weathered concerns that higher payroll taxes could stifle growth. Free cash flow surged 32% to $728 million during the past year. Earlier this month, Kroger agreed to pay about $2.5 billion in cash for Harris Teeter Supermarkets ($49; HTSI).

While per-share profits comfortably beat the consensus in the April quarter, investors seemed disappointed that Kroger didn't raise its full-year guidance by more than it did. Management is cautious, saying shopper sentiment remains fragile and that its stores still face sharp sales swings from one week to the next. Although shares slumped on Kroger's earnings report, they have since recovered to reach fresh all-time highs. At 14 times trailing earnings, shares trade 16% above their five-year median P/E ratio but 28% below the median for food retailers. Kroger is a Focus List Buy and a Long-Term Buy.

Two types of consumer stocks

The consumer-staples sector — home of companies that make food and household staples and sell groceries or prescription drugs — is known for its defensive characteristics. Yes, these companies rely on consumer spending. But for the most part, their businesses aren't too dependent on the economy.

In contrast, the consumer-discretionary sector includes a wide range of companies, including most retailers, hotel and casino operators, broadcasters, and makers of cars, motorcycles, or leisure products. These businesses tend to be cyclical, because they rely on spending consumers can reduce or eliminate when times get tough.

The line between the two sectors isn't always clear. Wal-Mart Stores ($77; WMT) and other super-center retailers are classified as consumer staples, while some manufacturerers of housewares might make more sense as staples than their current home, discretionary.

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