Saturday, February 21, 2015

A Single Sector Portfolio

If I had to pick one sector to put my entire portfolio in, its Consumer Defensive and its not even close. As this blog's motto says, the main things I look for in investing are safety, dividends, and growth. There are lots of areas of the stock market where these can be hard to achieve. For example, safety is pretty difficult in most financials since you do not know what they own. Dividends are tough to come by in many parts of sectors like tech, and growth is unpredictable in industrials and as we have seen recently - energy.

But what if there was one sector that could offer a measure of safety, stable dividend income, and slow but steady growth? I think there is one sector - consumer defensive stocks.

Morgan Housel makes the case that keeping things simple lets you focus on the most important thing - compounding. He cites research from Patrick O'Shaughnessy on the historical returns of consumer defensive versus other sectors.

I find this data very compelling. Total gobsmack stuff. Why? Think about it this way. With Healthcare you worry about patent cliffs, government intervention, and research pipelines. With Energy you worry about...well do I need to finish this sentence? Industrials are cyclical and many struggle to maintain a moat. Utilities and Telecom have limited growth. Technology firms' competitive advantage do not last from one decade to the next. Financials? Who even knows what you are buying and what they have on their books? Also, the management team can walk out the door tomorrow.

Morningstar's Heather Brilliant makes a point that is fundamental to long term investing - "The persistence of excess returns is much, much more important than the magnitude of excess returns"

Which brings us back to Consumer staples. If I had to pick one sector to put my entire portfolio in, its Consumer Defensive and its not even close. For high quality companies that generate high ROE and ROIC, have clean balance sheets, above average yields, steady dividend growth, and global exposure, I do not think you have to look any further than Consumer defensive.  On top of that, these are relatively easy companies to monitor and analyze. Most have no leverage or hard to understand issues, and the long run returns are not merely satisfactory, they are best in class.

Ordinarily, a single sector anything is a reason to be worried about risks and correlations. All of the other sectors have distinct risk factors, but about the biggest risk in consumer defensive is the risk of overpaying. Sure, its hard to get excited about buying Colgate-Palmolive for 30 times earnings. And there are some company specific risks for some products like tobacco and junk food, but as a group the biggest risk I see is overpaying. I just don't see the same correlations that you find in financials or energy.

As a proof of concept, here is a short list of 8 companies that sells for 22 times earnings. Not cheap, but with the S&P 500 at 20, this is a 10% premium to the market overall. The S&P's dividend yield is 1.9%, but these eight companies yield nearly double that at 3.5%. So that 10% earnings premium buys you a ton more income. The companies have excellent dividend growth track records and global exposure to boot.

P/E Dividend 5 yr Div Growth
Phillip Morris 17 4.7% 18.3%
Imperial Tobacco 21 4.4 13
Ambev 24 3.5 -1.3
Unilever 21 3.4 8.6
Nestle 24 3.2 16.9
Procter & Gamble 22 3.0 8.3
Diageo 24 3.0 7.5
Coca Cola 23 2.9 8.1
22 3.5 9.9
(Source: Morningstar)

Wallace Stevens' poem "Thirteen Ways of Looking at  Blackbird" contains this passage:

O thin men of Haddam, why do you imagine golden birds?  
Do you not see how the blackbird
Walks around the feet 
Of the women around you?

In this context, investors might ask themselves why try to imagine the next Tesla or biotech, do you not see the razor blades, shampoo, and candy bars around you?

I am not sure it needs to be any more complicated than that. As a postscript, here is a look at how the above eight companies performed from February 2005 to now (* note Phillip Morris is from March 2008 to now).

10 yr Total Return
Phillip Morris (*) 12.4%
Imperial Tobacco 11.2
Ambev 16.1
Unilever 11.4
Nestle 14.4
Procter & Gamble 7.6
Diageo 10.9
Coca Cola 10
(Source: Long Run Data)

No comments:

Post a Comment