Over the past 12 months, while the investment world has been concentrating on the success of FANG stocks, a bear market has developed in defensive consumer goods equities.
Shares in companies such as Kraft Heinz (KHC, Financial), Cambell Soup (CPB, Financial), Kellogg (K, Financial), General Mills (GIS, Financial) and Philip Morris (PM, Financial), all of which are mainstays of retirement portfolios, have seen their shares climb between 13% and 34% over the past 12 months, excluding dividends, compared to a gain of 14% on the S&P 500.
Following these declines, I'm interested in finding out whether or not these companies now offer value or look cheap compared to peer and historical evaluations.
Time to buy?
One of the first things to notice about these companies is that while the shares have declined significantly over the past 12 months, they still look relatively expensive compared to the broader market.
Philip Morris is probably the most obvious example. Shares in this tobacco company have come under pressure following the revelation about the business is not seeing as much demand as analysts believed it would for next-generation tobacco products. Following on from first quarter results -- when the worrying trend first emerged -- the stock has fallen 23% excluding dividends.
This decline reflects nothing more than a reversion to the mean for the business. Before 2016 the stock traded at a valuation of no more than 20 times forward earnings. In 2016 and 2017, as the hunt for yield accelerated, the valuation was pushed to a high of 28 times forward earnings. Now, it has fallen back to a more reasonable 15.5 times, which is only slightly below the five-year average in the run-up to 2016 of 16.2.
The same trend is evident throughout the basket of stocks listed above. Take Kellogg for example. In 2010 and 2011 the stock traded at an average multiple of 15.5 times forward earnings before ballooning to 37 in 2016. Now it has fallen back to a more manageable 15.
With this being the case, while it may look as if the market's most defensive stocks look cheap after the recent fall, if we move away from the stock price performance, it's clear that they're not cheap by historical standards at all. If anything, the recent declines have been a normalization of valuation. Valuations have declined back to more moderate levels, levels achieved before the hunt for yield accelerated throughout 2015, 2016 and 2017 when investors, faced with the prospect of negative yields on fixed income debt, plunged into equities.
This is an exciting guide to how the market is currently evolving. On the one hand, you have high-growth tech stocks, which are dominating regarding media coverage and deserve to trade at high multiples because of their outlook. On the other hand, you have these defensive stocks that have become overvalued in recent years when compared to historical valuations. Now that monetary policy is normalizing, we have the situation where mean reversion is dragging back down valuations.
Arguably these valuations are much more appropriate than they have been in the past two years, but that does not mean that the companies are cheap. They're anything but. The valuations have just come down two levels that can be considered reasonable based on historical data. In this environment it is essential to remember the cognitive bias of anchoring and the impact this may have on investment decisions.
Anchoring describes the tendency for investors to rely on the initial piece of information when analyzing a company, which in this case would be the fact that these stocks have declined by 20% or more over the past 12 months.
As shown above, however, these declines do not mean the stocks are cheap. The price of each share is lower than it was 12 months ago but on a fundamental basis, the companies are appropriately priced, looking at longer-term evaluation metrics. That being said, another decline of 20-30% from current levels may make these companies highly attractive.
Disclosure: The author owns no shares mentioned.
