Among U.S. companies, consumer defensives offer good value-investing opportunities. Such companies, like The Coca-Cola Co. (KO, Financial), PepsiCo Inc. (PEP, Financial), Proctor & Gamble Co. (PG, Financial) and The Wal-Mart Stores Inc. (WMT, Financial), have strong and consistent financial strength, suggesting low bankruptcy risk. Additionally, at least three of the above companies have strong gross margins, suggesting durable competitive advantage.
Brief sector overview
Unlike consumer cyclical companies, consumer defensive companies offer goods and services that are essential to daily life. Such companies are also known as “consumer staples:” a commodity that has constant demand regardless of the state of the economy. Examples of staple goods include beverages, household products and groceries.
As the name implies, the consumer defensive sector offers good defensive-investing opportunities. Table 1 lists the backtesting results for consumer defensive companies with a market cap of at least $1 billion that do not trade on the over-the-counter market, and compares them to the backtesting results for the Standard & Poor’s 500 index and the Dow Jones industrial average exchange-traded funds. We have ranked the companies by increasing financial strength, i.e. the companies with poor financial strength appear at the top.
| Year | SP 500 ETF | DJIA ETF | 5-stocks | 10-stocks | 20-stocks | 30-stocks | 40-stocks | 50-stocks |
| 2006 | 13.74% | 16.33% | 14.33% | 13.21% | 15.16% | 16.12% | 16.97% | 17.24% |
| 2007 | 3.24% | 6.54% | 5.77% | -0.35% | 5.46% | 5.45% | 8.64% | 10.72% |
| 2008 | -38.28% | -33.97% | -34.18% | -39.85% | -28.22% | -29.10% | -27.13% | -28.47% |
| 2009 | 23.49% | 18.91% | 13.66% | 18.77% | 24.19% | 23.48% | 23.84% | 30.68% |
| 2010 | 12.84% | 11.11% | 5.11% | 4.93% | 3.16% | 10.08% | 9.64% | 9.21% |
| 2011 | -0.20% | 5.38% | -14.54% | 1.34% | 1.42% | 1.93% | 6.29% | 2.10% |
| 2012 | 13.47% | 7.16% | 24.03% | 23.92% | 17.77% | 14.28% | 12.17% | 12.55% |
| 2013 | 29.69% | 26.72% | 82.60% | 61.12% | 38.55% | 35.89% | 33.33% | 29.01% |
| 2014 | 11.29% | 7.50% | 39.80% | 24.62% | 18.94% | 16.64% | 14.94% | 14.61% |
| 2015 | -0.81% | -2.19% | 2.36% | 6.06% | 14.98% | 11.98% | 10.24% | 11.02% |
| 2016 | 10.38% | 13.91% | 34.31% | 15.33% | 9.65% | 12.44% | 10.71% | 8.76% |
| Overall | 80.74% | 85.31% | 253.79% | 160.85% | 177.18% | 174.31% | 180.33% | 171.82% |
Table 1: Consumer Defensive Sector Backtesting Results, January 2006 – January 2016
When the test portfolio contained at least 20 company stocks, the loss in 2008 is at least 10% lower than the loss for the S&P 500 and the Dow ETFs in the corresponding year. This suggests that consumer defensive companies have lower loss potential than other companies do during recessions.
Historical financial trend analysis: Coke versus Pepsi
Atlanta alchemist John Pemberton founded Coca-Cola, a “distinctive tasting soft drink that could be sold at soda fountains,” in 1886. Seven years later, North Carolina pharmacist Caleb Bradham created direct competitor Pepsi-Cola. While both companies had fierce competition between each other, Coke and Pepsi currently have about 60% of the total market share of the global nonalcoholic beverage industry.
Both Coke and Pepsi suffered declining operating margins during the past 10 years, as illustrated in Figures 1 and 2. Coke’s operating margin remained steady around 27% from 2006 to 2011 before dropping to 21%. Despite this, the Atlanta beverage company maintained a 21% operating margin since 2012, outperforming 91% of global soft drinks companies.
Pepsi, on the other hand, had steadily declining operating margins from 2006 to 2015, but the margin increased to 15.59% as of December 2016. Pepsi’s operating margin, however, generally underperformed Coke’s, seldom exceeding 18% during the 10-year period.
Both beverage companies have high gross margins, implying durable competitive advantages. Coke’s gross margins outperform Pepsi’s by about 5%, they are sharply declining since 2011. On the other hand, Pepsi’s gross margins steadily increased since 2013 after reaching a 10-year low of 52% around July 2012.
Figure 1
Figure 2
As the company issued long-term debt, Coke had steadily weakening Altman Z-scores during the 10-year period. Both companies, especially Pepsi, have strong Z-scores nonetheless: even though Pepsi also issued long-term debt, the North Carolina beverage company had slightly increasing Z-scores from 2011 to 2016. Pepsi also had stronger Piotroski F-scores, as illustrated in Figures 3 and 4. This suggests that Pepsi has a more robust business operation than does Coke.
Figure 3
Figure 4
Although Pepsi generally had higher profitability, the North Carolina beverage company’s financial strength is slightly weaker than Coke’s financial strength, which reached a 10 out of 10 during 2009 and 2010. Despite this, Pepsi currently has a two-star predictability rank, which outperforms Coke’s one-star rank. Figures 5 and 6 display the companies’ Predictability Chart. As of December 2016, both beverage companies have a financial strength rank of 6 and a profitability rank of 7.
Figure 5: Predictability Chart for The Coca-Cola Co. (KO, Financial) ★
Figure 6: Predictability Chart for PepsiCo Inc. (PEP, Financial) ★★
During the past 10 years, however, both Coke and Pepsi had strong predictability, with the latter reaching five-star status by January 2013. Pepsi’s predictability rank steadily increased since 2006 before dropping to two stars in January 2016. On the other hand, Coke’s business predictability is more volatile, remaining at one star until 2009 and dropping back to one star January 2016. Figures 7 and 8 summarize the two companies’ historical financial strength, profitability and predictability trends.
Figure 7
Figure 8
Warren Buffett (Trades, Portfolio) likely prefers Coke to Pepsi as he owns 400 million shares of Coke as of third quarter 2016, as shown in Figure 9. The Berkshire Hathaway Inc. (BRK.A, Financial) (BRK.B, Financial) CEO still owns the largest stake in Coke, with 9.27% of total shares outstanding. Donald Yacktman (Trades, Portfolio) and Ken Fisher (Trades, Portfolio) own 16,823,205 shares and 10,561,309 shares, respectively.
Figure 9
Proctor & Gamble
Cincinnati based Proctor & Gamble Co., commonly referred to as P&G, offers an eclectic variety of consumer packaged goods from five business segments: Beauty, Grooming, Health Care, Fabric Care and Home / Family Care. The company has moderately strong financial strength albeit a one-star predictability rank. P&G’s operating margin generally increased during the 10-year period, expanding to a 10-year high of 20.59% as of December 2016. Additionally, this margin ranks higher than 90% of P&G’s competitors. However, P&G had volatile gross margins as illustrated in Figure 10.
Figure 10
P&G CEO David Taylor discussed likely reasons for expanding operating margins in the company’s fiscal first quarter of 2017 earnings report, including “broad-based organic sales growth” and strong cost savings across their product categories. The company finalized their Beauty Brands divestiture to Coty Inc. (COTY, Financial) Oct. 3, allowing P&G to focus on their balance of “strong top-line growth, bottom-line growth and cash generation.”
Although the company had strong operating margins, P&G had volatile Piotroski F-scores, which generally oscillated between 4 and 8 during the 10-year period (see Figure 11.) Despite this, the Ohio-based packaged goods company had steadily increasing Altman Z-scores, exceeding the safe threshold of 2.99 by 2011. The company’s Z-score is currently a strong 3.78, which likely contributed to good financial strength scores. Figure 12 summarizes P&G’s historical financial strength, profitability and predictability trends.
Figure 11
Figure 12
Yacktman, who invests based on the forward rate of return, owns 16,032,753 shares of P&G as of third quarter 2016, the largest stake among P&G gurus. Figure 13 shows the guru’s trade history in P&G for the past six years.
Figure 13
Wal-Mart
Among Wal-Mart, Coke, Pepsi and P&G, Wal-Mart currently has the highest predictability rank of 3.5 stars. This suggests that the Bentonville discount-store company offers a good defensive-investing opportunity.
Despite having the lowest profit margins among the four companies, Wal-Mart has a steady Altman Z-score in the 4-4.5 range. Figure 14 summarizes Wal-Mart’s historical profit margin trends while Figure 15 summarizes Wal-Mart’s historical F and Z score trends.
Figure 14
Figure 15
Even though the company had a wide range of F-scores, Wal-Mart had less volatile predictability than Coke, Pepsi or P&G. As illustrated in Figure 16, Wal-Mart maintained a five-star predictability rank from 2008 to 2014 before rescinding the prestigious five-star rating in 2015. The company’s predictability rank dropped to its current rating of 3.5 stars January 2016.
Figure 16
Conclusions and see also
As of Dec. 19, the U.S. total market index is 126.6% greater than the country’s gross domestic product. The “Buffett indicator” implies an average return of -0.4% over the next eight years, including dividends. Such a market calls for defensive investing, i.e. investing in companies in the consumer defensive and health care sectors.
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Disclosure: I do not have any stock positions in the companies mentioned in the article.
