As bad economic news has become good news relative to the stock market once again, we see many investors/traders shifting to sectors viewed as “defensive” – in our view, it appears they want to be in the equity markets, but want exposure that is considered less “risky”. To many investors, we believe Consumer Staples’ companies fit this mold. Why? Because we believe in an economic downturn, if consumers have to make tough choices, they will continue to buy the things they can’t live without – so called “staples” (i.e. toilet paper, laundry detergent, food, etc.). But what happens, when these companies are already trading at the high end of their historical value ranges and business models are increasingly at risk?
To illustrate our case, let’s look at some valuation metrics. Consumer Staples stocks trade a P/E premium to the market overall (20.1x for S&P500 CS vs. 17.4x for S&P500) with approximately 65% of the expected growth. Further, based on PEG Ratio (P/E/Growth), the S&P 500 Consumer Staples sector trades at roughly a 77% premium to its 10-year average and the market overall. On the business side of the ledger, we believe these companies tend to get squeezed by Amazon, Walmart and others to lower prices, face increasing input and labor costs and struggle to deliver a customized consumer experience without non-advertising based purchasing data.
Generally, these circumstances do not suggest potential safety to us. We think when investors “pile” into a popular directional trade it often leads to an overbought situation where traditional value metrics don’t matter. As we see it, if you aren’t nimble enough to trade in and out of these short-term moves that ignore underlying fundamentals – and it appears very few are able to do it successfully, there can be disappointment when sentiment changes, especially as volatility increases.
Generally, while we are cognizant of specific sector headwinds or tailwinds and factor that viewpoint into our individual company scoring, our analysis is overwhelming company-specific. We believe by finding companies that can grow despite the economic conditions in which they find themselves can potentially reduce risk and provide “safety” of a different, more enduring kind – in our humble opinion.
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The views presented herein are those of Validus Growth Investors, LLC and are provided for informational purposes only. The information is current as of June 2019 and is based on the economic and market conditions as of this date. The information is not intended as a discussion of the merits of a particular offering and should not assume that any discussion or information provided herein serves as the receipt of, or as a substitute for personalized investment advice from Validus Growth Investors, LLC or any other investment professional.
This material is provided for informational purposes only and does not constitute a solicitation. The material is not intended to be relied upon as a forecast, research or investment advice and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any forecasts made will come to pass.
The S&P 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies. Comparisons to indices are inherently unreliable indicators of future performance. An investor cannot invest directly in an index.
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