When Jeremy Siegel and Jeremy Schwartz were doing research for the book The Future for Investors, they wanted to find the best performing stock from the original 1957 version of the S&P 500[i]. What they found wasn’t an exciting technology stock, or a behemoth oil company, but rather a simple consumer stock: cigarette maker Philip Morris (now called Altria Group). What’s more, Siegel and Schwartz found that 11 of the top 20 long-term performers came from the same boring economic sector: consumer staples. The sector is defined by great brands, wide economic “moats,” and above market returns on equity. So how can you use consumer staples stocks in your portfolio? My plan is to answer that question in a multi-part sector series.
For each of the ten economic sectors, I’ll write two parts. Part one will be an overview. I’ll tell a quick history, highlight important companies, and discuss any interesting trends or characteristics. In Part two, I’ll explain how you can find the best investments in each sector, and discuss when the sector does well across market cycles. (Click here for Part II)
At first, I’ll focus on American stocks for a few reasons. First, they are more recognizable and therefore more interesting to U.S. investors. Second, U.S. stock data is clean, broad, easy to work with, and has a deep history. Depending on the popularity of this sector series, I may expand globally as well, perhaps collecting a similar analysis into an e-book (so let me know what parts you enjoy and what you find boring). We’ll start with the consumer staples sector which, as we’ll see, has been the best performing sector in the U.S. market since the early 1960’s.
A Peculiar Sector
The reason consumer staples stocks caught my eye was a bit of research I was doing on returns on equity (ROE). Over the past 50 years, consumer staples stocks have had persistently excellent returns on their equity. They haven’t obeyed the same ROE mean reversion that other economic sectors do. Because outsized profits and rates of return on equity should attract stiff and serious competition into an industry, it’s fascinating that an entire sector could enjoy above market returns on equity for so long.
Such sustained excellence must mean that these companies have had impressive “moats” around their businesses—barriers to entry in the form of brand, economic scale, or other advantages that make it very hard for newcomers to knock off the market leaders. Warren Buffet, Charlie Munger, and other great investors have often said that a good moat is one of the most important attributes for any company. For more information on moats, read this great piece by Michael Mauboussin.
The consumer staples sector is divided into 3-primary groups (known as industry groups) by S&P’s Global Industry Classification Standard (GICS). These are food & staples retailing (think Wal-Mart), food beverage & tobacco (think Coca-Cola), and household & personal products (think Proctor & Gamble). Here are the number of stocks in the sector (and in each industry group) over time.
There have never been more than 200 consumer staples stocks in the all stock universe[ii]—it has always been a fairly concentrated and top-heavy sector. One convenient measure of concentration is to measure how much of any market is controlled by the top companies. One well known measure is the “four firm concentration ratio,” which simply adds up the market share (% of total sales) of the top four firms in each industry group. Here is the historical concentration of each group:
Today, roughly 75% of the sales in both the food & staples retailing and the household & personal products industries come from just the top four companies.
Historical Returns
Though it is populated by companies that seem plain vanilla and don’t excite with new technologies, the consumer staples sector has been the best performing of the 10 economic sectors since 1963. Below are the annualized returns for each of the ten economic sectors[iii].
In addition to delivering the highest returns, consumer staples stocks have had the second lowest annualized volatility, trailing only utilities for lowest annual standard deviation of returns.
Within the sector, returns for the food, beverage & tobacco industry group are especially impressive, while household & personal products have had returns similar to the rest of the market.
So why do these two industry groups do so well? Part of the answer is extremely effective economic moats, mainly resulting from powerful and iconic brands. Warren Buffett has ridden this trend to success—to this day three of his largest holdings are Coca-Cola, Anheuser-Busch (Beer), and Proctor & Gamble.
Food, Beverage & Tobacco
The largest (and best performing) industry group is food, beverage and tobacco. Some of their success comes from the fact that as a group they’ve earned exceptional returns on their equity across history, well above the rest of the market as seen below. Unlike an industry like automobiles—which are the ultimate cyclical stocks—these companies do not show strong mean reversion in their collective return on equity.
It is amazing, but market trends like these often come down to just a few companies. Coca-Cola and Pepsico, for example, represent about 25% of the food, beverage & tobacco industry group’s common equity. Since both have had high ROEs, they are a major reason for the sustained dominance of the industry.
Outstanding Long-Term Returns
Thinking back to The Future for Investors, I wanted to update the research on long-term returns by looking for the best performing stocks in the U.S. since 1963 (using all stocks as a universe rather than just the S&P 500). My criteria was that the stock was around in 1963 and survived through the present. Sure enough, Philip Morris (now Altria) was the number one performing stock with an annualized return of 20.23% per year since 1963—that is a total return of more than one million percent! Other consumer staples stocks peppered the top thirty stocks: Hormel Foods, Anheuser-Busch, Pepsico, and Coca-Cola (among several others) were all near the top of the list.
Clearly, consumer staples stocks have been great investments over the long-term. Lucky for us modern investors, we can buy staples using a low cost ETFs. Of course, sector ETFs are market-cap weighted so there may be a better way. Improving on a market-cap weighted strategy will be the subject of part two: how to find the most attractive consumer staples stocks in any given market. Stay tuned!
SIDE NOTE: With each of these posts, I am learning. I would love to hear from you with ideas, questions, or disagreements about what matters most in each sector. Email me at patrick.w.oshaughnessy@gmail.com with any thoughts.
[i] Pg 36 of The Future for Investors by Jeremy Siegel
[ii] All stocks = any stock in the U.S. with an inflation adjusted market cap>$200MM
[iii] Each custom sector index (and industry group index) is constructed as follows: first, every stock with an inflation adjusted market cap floor of $200M or higher is included. Stocks must be domiciled in the U.S., so no ADRs. Stocks are then equally weighted in the index and the index is rebalanced using the same criteria once per year in December.