Having your cake and eating it too!
Sometimes you can have your cake and eat it! In investing that
means buying stocks with good defensive growth characteristics. In
May 2010, we began to research a set of eight companies - Coca-Cola
), McDonald's (
), Procter & Gamble (
), Colgate (
), Johnson & Johnson (
), Wal-Mart (WMT), Kellogg (K) and Kraft (KRFT). The European
equivalents - Unilever (UL), Diageo (DEO), Reckitt Benckiser
(RBGPF) and Kerry (KRZ.IR) - were added to the list in 2011. Kraft
has since de-merged and we have substituted Mondelez (MDLZ) (the
spin off from Kraft) in Kraft's place.
The aim of this thematic research, which we have come to term
the 'US Global Consumer Defensive Franchises Theme' has been to
find a lower-risk way of obtaining the returns on offer from
markets over time by owning a portfolio of stocks that are global
brands, financially strong, have a history of delivering growth and
are defensive in recession. This note is an update on the progress
of the theme, and the first chart tells the story well.
Since 1988, the earnings of these eight US global defensive
consumer franchise stocks (blue line) have been uninterrupted, in
aggregate. That is, the collective earnings of these eight
companies never declined in any single year since 1988. While
individual companies in the theme experienced a decline in earnings
from time to time, collectively their earnings continued their
upward march, and at a steady pace. Over this 24-year timeline,
earnings at these eight companies grew at 9.9% compound
In contrast, earnings at the 500 companies making up the S&P
500 Index have grown at a lower 5.7% compound
rate over the same 1989 to 2013 timeline, and the progress of those
earnings was erratic. Most companies are cyclical and their
earnings decline in recessions. On three separate occasions,
earnings for the S&P 500 declined-in the 1991 recession, the
2001-03 recession, and the 2007-09 global credit crisis.
In other words, the eight stocks we chose for the US Global
Defensive Consumer Franchise Stock Theme in May 2010 all had
special characteristics. They had a competitive advantage of one
sort or another, global reach, and demand resilience. The list was
not an exclusive one. There are other stocks with these
characteristics, but a list of eight provided sufficient
The competitive advantages that these companies possess - more
than anything else - is strong branding and global distribution.
Through high quality manufacturing, persistent advertising and/or
cost competitiveness, each of these eight companies has managed to
bring to market a suite of products that the consuming public are
convinced (rightly or wrongly) are the best products available. In
some cases, consumers are prepared to pay premium prices for the
respective company's products, which provide these companies with
higher margins and returns on capital employed. In other cases,
such as Wal-Mart and McDonald's, a superior offering may be driven
by low prices, which results in growing market share. The
positioning of each company in its relative market is so strong
that words like 'Coke', 'Kellogg', and 'McDonald's' have become
synonymous with soft drinks, convenience food and fast food. This
achievement has several advantages:
- Firstly, consumers will choose these companies before any
- The companies can pass on increasing input costs to their
consumers who are relatively price insensitive and will choose to
buy these consumer goods anyway.
- In recessionary environments, these products are positioned
in people's lives such that consumers either cannot do without
them (essentials) or would really rather not do without them
(essential luxuries). The relatively small prices of their
products and the repeat (almost daily) nature of consumer
purchases of their products means that demand rarely declines
even in recessionary times.
Global distribution is another weapon in most of their armories.
Many of these companies already have the infrastructure in place to
take advantage of the growing middle class incomes in the
developing world - particularly in China, India, Asia, Latin
America and, more recently, Africa.
Growth in earnings for the US global consumer franchise stocks
since the theme was introduced in May 2010 has been 6% compound
against 13% for the S&P 500. Earnings for companies in the
S&P 500 were still recovering from cyclically depressed levels
in 2010, 2011 and 2012. But over the long haul, it is the defensive
US global consumer franchise stocks that have delivered the better
growth and with more consistency, as the earlier chart
Better Value than Government Bonds
As their earnings are so consistent, the US global defensive
consumer franchise stocks can more easily be compared to the
(guaranteed) income available from government bonds.
The next chart shows the earnings yield (blue line) of this
portfolio of eight stocks from the start of 1989 to the end of
2013. The earnings yield represents the amount of earnings you have
bought at the current share prices. For example, if Coca-Cola is
expected to have earned $2.10 a share in 2013 and you buy the
shares today at $40, then you are buying an earnings yield of 5.25%
($2.10 / $40* 100= 5.25%).
The historic earnings yield available from these eight companies
at the end of December 2013 was 5.3%. The yield available from the
US 10-year government bond was 3.0%. Yet, the earnings yield can be
expected to grow in the years ahead as these global defensive
franchise stocks generate growth by introducing new products,
expanding into new regions and, in some cases, buying back
As the chart highlights, in late 1999 the earnings yield
available from this portfolio of stocks was circa 3%. At that same
time, the risk-free US 10-year bond was offering a yield of over
6%. In late 1999, the value was in the US bonds, and not in these
stocks. Today, however, the value continues to reside in these
stocks, and by a wide margin. In other words, relative to the value
on offer in the main alternative asset class, US long-dated bonds,
the US global defensive consumer franchise stocks still offer good
Not Overvalued Relative to History
Lastly, it is worth revisiting how these stocks are valued today
relative to how investors have valued them in the past.
The next chart highlights that investors have, on average, paid
21 times the earnings of these stocks since late 1988.
Currently, investors are paying 18.6 times historic earnings for
these companies. This is still below the long-term average.
For 2013, earnings per share for the S&P 500 are expected to
come in at $96.40. At the current index level of 1,848, investors
are paying 19.2 times earnings for the S&P 500.
The next chart (taken from the
Federal Reserve Economic Database
) displays the after-tax corporate profits of US businesses and
expresses them as a percentage of GDP.
Currently, US corporate profits are 11% of GDP, some 4.6% above
the long-term trend of 6.4%. The chart indicates that,
historically, any time profits have moved past 7-8% of GDP, they
have reverted back to (and often below) the long-term average.
Today, US corporate profits are at their highest point in 66
years, suggesting that there remains a risk that corporate earnings
in the US could, once again, revert to the mean, and downwards.
This suggests that S&P earnings are similarly at risk of a mean
reversion in margins. However, one cannot make the same argument
that earnings at the US global defensive consumer franchises are at
The question must then be asked: why would an investor own the
S&P 500 (via an exchange-traded fund or otherwise), which is
composed of businesses with a higher risk to current earnings in
the coming years yet which trade at over 19 times those earnings,
when he could own a portfolio of global defensive consumer
franchise stocks with better earnings resilience and which are on
offer at a slightly lower 18.6 times earnings?
Investors may be prepared to pay more today for the earnings of
the S&P 500 on the basis that earnings for the index are
expected to grow strongly in 2014. However, history suggests that
over the long-haul earnings at the S&P 500 have not outpaced
those of the US global consumer franchise stocks. We, therefore,
find it odd that investors are currently paying more for the
earnings of the S&P 500.
In all, we see little valuation risk in the US global defensive
consumer franchise stocks either in terms of:
- How investors have valued them in the past;
- The alternative value on offer in US 10-year bonds; or,
- The alternative value on offer in the S&P 500 Index.
Since May 2010, the eight US global defensive consumer franchise
stocks have gained circa 45% on average (excluding dividends). Over
the same period, the S&P 500 Index has advanced 65%.
Nonetheless, the theme remains a low-risk one and it is our view
that these giant consumer stocks can continue to deliver annual
returns of perhaps 7-8% from here including dividend income.
I am long KO, MCD, PG, CL, JNJ, WMT, K, KRFT, UL, DEO, RBGPF, MDLZ.
I wrote this article myself, and it expresses my own opinions. I am
not receiving compensation for it. I have no business relationship
with any company whose stock is mentioned in this article.
I am also long an Irish stock listed on the ISEQ - Kerry Group plc
A Few More Reasons Why I Am Bullish On J.C.