Thursday, September 8, 2011

Look Outside of Consumer Staples for Value Today

I recently have urged the purchase of stocks in cases where investors have substantial cash reserves.  This is not, however, a sweeping endorsement of stocks at current levels.  In general, consumer staples stocks offer poor value, as institutional investors who are compelled to remain fully invested apparently have rotated to this sector for its earnings stability and presumed relative safety if the seasonal tendency for stock market declines in September and October occurs again this year.

I find little appeal in this sector.  Colgate, Coca-Cola, and Heinz, for example, trade at nearly 18 times current, calendar-year earnings.  The estimated long-term earnings growth rate is 7-9%, with dividend yields of 2.5%-3.6%.  I like to compare the sum of a company's sustainable growth rate and its dividend yield to the p/e multiple.  In this case, earnings growth plus dividend yield is about 11%, and the p/e is 18, for a ratio of 0.6.  A ratio of close to 1.0 represents much better value.

The staples companies also generate relatively little free cash flow after capital spending and dividend payments, and their debt/equity ratios are unimpressive.  Yes, they have large international operations and growth prospects in emerging markets, but at 18 times earnings, I'd say that's amply reflected in the price and investors should look elsewhere.

Steve Lehman

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