Conservative Investors, Consumer Companies in a Sluggish Economy

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Coca-Cola sold one billion cases in China in the first six months of 2011.
Coca-Cola sold one billion cases in China in the first six months of 2011.

With investors worried about overwhelming debt burdens in the United States and Europe, the Standard & Poor's 500 index sank 5.4% in August 2011. But not all investments were losers. For the month, Vanguard Consumer Staples Fund stayed in the black. The performance was not surprising. The Vanguard fund holds shares of such rock-solid consumer companies as Kraft Foods and Walgreen. People must buy food and drugs constantly—even in recessions. “Consumer companies deliver steady earnings, so they tend to hold up during economic downturns,” says Wade Stinnette, portfolio manager of FBR Balanced Fund.

Because they avoid big losses in downturns, top consumer stocks have produced strong long-term returns. During the rocky markets of the past decade, consumer funds returned 7.2% annually, outdoing the S&P 500 by more than four percentage points, according to Morningstar.  At a time when the economy seems likely to remain sluggish, consumer stocks could serve as anchors for portfolios of conservative investors.

Make no mistake: Consumer stocks do not lead the markets every year. During bull markets, investors often ignore consumer goods, which may seem dull compared to technology or finance. But over the long haul, consumer stocks tend to deliver competitive results.

Consumer stocks account for about 10% of the assets in the S&P 500. The group includes a range of businesses. Prominent on the list are food and beverage producers, including ketchup maker H. J. Heinz, cereal producers General Mills and Kellogg, as well as soft drink giants Coca-Cola and Pepsico.

Other consumer companies make household products as well as health and beauty aids. Among the biggest are Colgate-Palmolive, the toothpaste producer, and Procter & Gamble, which makes Tide detergent and Crest toothpaste.

An especially safe choice is Coca-Cola. The beverage company is enormously profitable, and the business grew steadily throughout the financial crisis of recent years. Growth of the soft drink business is slowing in the United States, but Coke has ceased to be primarily an American company. Most sales and earnings come from overseas, where the company is expanding steadily. Some of the most rapid growth has been reported in the booming economies of Asia and Latin America. The company recently announced that it had sold one billion cases in China during the first six month of 2011, double the figure of five years ago. “Coca-Cola has little debt and tremendous growth prospects,” Stinnette says.

Stinnette particularly likes the stock because it pays a dividend yield of 2.9%. That is a relatively rich payout at a time when 10-year Treasury bonds yield only around 2.2%. Coca-Cola is among the most reliable income sources. The company has increased its dividend payment for 49 consecutive years.

Like Coca-Cola, Pepsico is a steady income producer. The stock pays a dividend yield of 3.3%, and the company has increased the dividend annually for three decades. Besides reporting strong growth of its soft drinks, Pepsico is showing gains in its other products, including Tropicana orange juice and Quaker oatmeal. More than one third of sales come from the emerging markets. “Pepsico offers a relatively safe way to benefit from the growth in Asia,” says George Shipp, portfolio manager of Sterling Capital Equity Income Fund.

Another way to bet on consumer stocks is to own retailers that sell food and household goods. A solid choice is Wal-Mart Stores, the biggest retailer in the world. While the recession has slowed the growth of the chain, the company is continuing to open new outlets in the United States and expand rapidly in Latin America and other regions overseas. In the second quarter of 2011, revenues grew 5%. “Wal-Mart has exciting potential in the emerging markets,” says Jeff Auxier, portfolio manager of Auxier Focus Fund.

To own a fund that focuses on the sector, consider Rydex Consumer Products Fund, which has returned 7.7% annually during the past decade. The fund has a big stake in Mead Johnson Nutrition, a company that is especially reliable because it sells infant formula under brand names such as Enfamil. With sales growing in emerging markets, the company has been increasing its earnings at a 22% annual rate. Other holdings in the Rydex fund include Kimberly-Clark, the maker of Kleenex brand tissues and Estee Lauder, the cosmetics company.

For more diversification, you can try a fund that holds consumer stocks as well as holdings in other sectors. A top performer is Sterling Capital Equity Income, which has about a third of its assets in the consumer sector. During the past five years, the fund returned 3.8% annually, outdoing 99% of its competitors. Sterling often excels in downturns. When the S&P 500 lost 37.0% in 2008, the fund outperformed by 11 percentage points.

Portfolio manager George Shipp favors companies with solid balance sheets and the ability to grow consistently. He favors companies that can steadily raise their dividends. A favorite holding is hamburger giant McDonald's, which has increased its dividend annually for more than 30 years. Sales have been climbing briskly.

Another steady fund is Ave Maria Rising Dividend, which has 39% of its assets in consumer stocks. Many holdings in the fund are so solid that they could raise their dividends substantially during the financial crisis. Portfolio manager Richard Platte avoids steel companies and other cyclical businesses that can sink in recessions. A favorite holding is bleach maker Clorox. The company faced some headwinds recently when the cost of raw materials rose. But Clorox has continued to increase its dividend and report growing earnings.

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