Consumer staples stocks aren't cheap but dividends and a safety play should put them on your radar for 2020
Of the nearly 900 stocks in the consumer staples sector, which are your best investment for dividends and protection from whatever the stock market brings?
I’m screening through all 900 companies to reveal the five best consumer defensive stocks for your money. I’ll not only walk you through how to find these stocks but show you two ETFs you can use to get instant diversification.
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Dividend Yield and Safety with Consumer Staples Stocks
Nation, I am loving our sector stocks series and more than 40,000 of you have tuned in to see the best stock picks from each sector. We’re five videos into the series and this could just be my favorite for investing over the next year.
Now we’ve talked about the state of the economy in other videos, how this 10-year bull market is wobbling on the edge and the factors I’m watching that could mean tough times for investors within the next year.
But you can’t just sit out the market. Trying to time the next stock market crash is like trying to drive over a bridge before it’s finished. Sometimes being too early is as bad as being too late.
Fortunately, consumer staples stocks are some of the best long-term, high dividend stocks you can buy that will not only give you the opportunity to stay in this market making money but also protect your portfolio if the market crashes.
If you look at the consumer staples fund, in the green line here, against the broader market leading into the 2009 stock market crash. Consumer staples stocks dropped less than half of what we saw in the S&P 500 over the period.
How to Find the Best Consumer Staples Stocks
In this video, we’ll start by showing you why consumer staples stocks are able to benefit from a strong market as well as protect you from a crash. I’ll show you how as an equity analyst for private wealth I used to pick these high yield stocks for clients. Then I’m going to reveal two consumer staples funds ETFs and five of the best consumer staples stocks that should be on your radar for 2020.
If you’re just joining us, we’re doing 11 videos to reveal the best stocks to buy in each sector of the economy. I’m looking at each sector from tech to energy, consumer goods and utilities to show you how to find the best of breed companies in each and create that diversified portfolio for growth and cash flow.
This is hugely important because even though I love those dividends in these defensive stocks, you have absolutely got to have investments in those other sectors. It’s going to give you the diversification you need to grow your portfolio no matter what the economy brings.
What are Consumer Staples Stocks?
Here we see the 11 sectors of the economy and remember, each sector is made up of different industries that work in the same product or service. And today we’re talking about all those products you buy no matter what the economy does, the food, household and personal products, the beverages and even maybe some of those adult beverages.
We see that over the last five years, the consumer staples sector has lagged the rest of the market pretty badly returning just 27% against that return of 51% on the S&P 500. Over the last year the sector has only returned 6.8% versus an 11% gain on the market. In fact, only the energy and health care sector have done worse for returns.
But there’s good reason to believe the staples might just turn this around in 2020 and why you need these in your portfolio.
You see, because consumer staple stocks pay out such huge dividends, they behave a lot like bond investments when it comes to interest rate changes in the economy. When interest rates decrease, investors start looking for high yields in bonds and stocks in this sector and the prices go up. When rates increase, investors can get higher yields in other investments so they abandon the staples and prices drop.
That’s what happened to consumer staples over the last few years. You see in a chart of the consumer staples sector ETF and the S&P 500, pretty much tracking each other perfectly from 2009 to late 2015.
Sure enough though, when the Fed started raising rates in December 2015, the pain started for these dividend stocks. The market started outperforming and consumer staples flatlined.
But we’re seeing the opposite of this play out right now with the Fed cutting interest rates three times since July 2019. Investors are again searching for those high yield dividend plays and could come back to consumer staples in a big way.
How to Pick Consumer Stocks
So before I highlight those two funds and the five stock picks in the sector, I want to show you two factors you can use to find stocks on your own. Everyone in the nation knows, I’m not about to just lay down five stock picks because that does nothing for you.
DO NOT just come on YouTube or tune into CNBC to get stock picks. Understand how you find these and use that power to have that control over your money. DO NOT give someone on TV control over your investments.
Now these two factors are above and beyond the fundamentals we talked about in the first video in the series. I’m using trends in revenue, operating margin and catalysts to pick stocks in the sector series but these next two are extra ones you absolutely must be watching for when you pick consumer staples stocks.
But the first factor here for consumer staples stocks is going to be the payout ratio.
The payout ratio is the single most important factor for making sure that dividend on the stock is going to keep paying out. This measure is the percentage of a company’s profits or net income is going to pay the dividend.
The payout ratio is important for a couple of reasons. First because a company stretching to pay its dividend, pushing all the profits out the door to cover, probably isn’t going to be able to pay that dividend for much longer. If a company is paying out 65% or 75% of its profits to the dividend, it doesn’t take much of a hiccup in profits until they have to cut the dividend.
Also though, a company paying out much more of its profits to investors probably isn’t saving enough back for growth versus its competitors. That’s going to mean missed opportunities and lost market share, and eventually falling profits.
So what I’m doing when looking at consumer staples stocks is comparing the payout ratio across companies. There’s no right or wrong answer here but you’re trying to find companies that already offer a solid dividend but are maybe paying less of their profits out for that dividend, so companies that can afford to increase the dividend.
Finding the payout ratio means just taking the annual dividend amount per share and dividing by the earnings per share.
The next factor here before we get to those two funds and five stock picks is making sure these companies have a quality balance sheet.
This one takes a little more digging but with rock-bottom interest rates, companies have been on a buying binge for more than a decade. They’ve been borrowing to buyback stock, they’ve been borrowing to make big expensive acquisitions. And it’s led to a mountain of massive debt.
In fact, it was this massive debt that killed Kraft Heinz after its 2015 IPO from private equity. One of Buffett’s top picks that year and it’s now trading for less than half its price because that debt took away the financial flexibility to stay competitive.
What you want to look for here is going to be measures like debt-to-equity and how much of earnings are going to make the interest payments. Again, just like that payout ratio, it’s not so much the absolute level of debt or these measures but how they compare against other companies. You want to be investing in companies with relatively low measures of debt compared to their competitors.
Consumer Staples ETFs to Buy
Now just like in the other videos, we’re going to start off with a couple of consumer staples ETFs before we get to those five stock picks. These funds are going to be a great way to get that sector exposure if you can’t find individual stocks you like or maybe you just want a little more diversification.
Our first here is the Consumer Staples Select Sector SPDR, ticker XLP, with a 2.6% dividend yield and an expense ratio of just 0.13% annually.
The XLP holds shares in 33 companies in the sector and based in the United States and has returned 12% annually over the last decade. You can see here it’s well diversified across all the industries in the sector from beverages to food and household.
For the other fund, I wanted to show you an international option so we have here the iShares Global Consumer Staples ETF, ticker KXI.
Like a lot of smaller funds, the expense ratio is higher at 0.46% but the dividend is solid and this one is going to give you a broad exposure to the global consumer. Half of the fund is invested in U.S. companies but you’ve also got exposure to Europe, Australia and Asia.
Here you see that the KXI and that larger XLP fund have tracked each other pretty closely but there is some opportunity here when the two move out of step, maybe positioning into the cheaper shares for the bounce back.
Best Consumer Staples Stocks for 2020
Now I want to reveal five consumer staples stocks I found that should be on every investor’s radar. I’ve got some bellwethers here, those popular brands everyone loves, as well as a few surprises. I’ve ranked them here by dividend yield so we’ll be counting down to the highest dividend in the sector.
PepsiCo, ticker PEP, is our first pick and its 2.9% dividend puts it on the bottom of the list but the total return on shares makes this a solid investment.
Shares have produced an 11.5% annual return over the last decade, above the 10% annual return on shares of Coke. And I gotta tell ya, I like the taste of Coca-Cola better but the fundamentals for Pepsi go down a whole lot easier.
Between the two, they control over 70% of the non-alcoholic beverage market which give them both massive pricing and distribution power. Pepsi’s annual sales are almost exactly twice that of Coca-Cola though and it’s payout ratio leaves a lot more room for growth.
Pepsi pays out just 68% of its earnings to cover the dividend versus Coca-Cola which needs 78% of its earnings to cover the dividend.
Shares of Pepsi don’t come cheap, something you’ll see in any stock in the sector, trading for a price of 24-times earnings. Profits are expected about 4% higher over the next year though I would put them closer to six percent higher given management’s history of beating expectations.
We see a broad band of price targets for the 11 analysts covering Pepsi with a low target of $115 and a high target of $155 per share. Despite the lackluster targets, this is one you can put in your portfolio and forget about and you’ll always know it’s going to produce.
Next here is Kimberly-Clark, ticker KMB, the $45 billion personal care products giant paying a 3.1% dividend yield.
What I’ve tried to do here as we’ve seen in those other videos in the series is to pick some of the best stocks across the different industries in the sector. So here with KMB you’ve got personal care products, we had beverages and snacks with Pepsi and we’ll see some of the other industries in our next picks.
What I really like about Kimberly-Clark though, besides the fact it’s only paying about 61% of its profits to cover the dividend which leaves a lot of room for growth, what I love here is that the company has been reinvesting an average of $5 billion annually over the last five years into product development and marketing.
You don’t see that level of reinvestment at its competitors so what I think could happen in the coming years is that KMB reaps those benefits with faster revenue growth and cash flow.
Shares trade for 19.6-times earnings which are expected 5.8% higher over the next year but I think those surprise revenues start to play out.
Analysts have a low target of $123 per share to a high target of $155 each for the stock over the next year and I like it at least up to that $150 per share for a long-term bet.
Now this next one is going to be one of the big surprises here, Kraft Heinz, ticker KHC and its 4.9% dividend yield.
I’ve warned investors against Kraft Heinz since starting this channel and yes, even used it as the poster child for a bad balance sheet earlier in this video.
But I’m calling it. Shares are down almost 60% since the 2015 listing and there’s a lot to like about the stock going forward.
Kraft cut its dividend late last year which absolutely destroyed the shares but now it’s paying just 54% of earnings to cover the payout. That’s supporting cash flow, helping it to pay down some of that debt and stay competitive in the market.
The company has $2.3 billion in balance sheet cash, is the third largest food and beverage manufacturer in North America…and let’s not forget that Buffett’s Berkshire Hathaway still owns almost $11 billion in shares, that’s more than 25% of the company and you better believe he’s pushing for profits.
Shares of Kraft trade for just 11.2-times earnings, making it one of the cheapest consumer staples stocks you’ll find. Earnings are expected to be down 13% over the next year but margin gains reported last quarter make me think they can beat this number.
This is a stock that analysts have all but given up on with a low target of $23 a share and a high of just $34 each, right around where it’s trading now. I don’t want you to think this is going to be a magical ride higher. Investor sentiment is still negative on the stock but there’s a lot of value here for investors willing to take a shot and hold for the long-term.
Big Lots, ticker BIG, is another risky one but paying a solid 5.6% dividend here and some good fundamentals.
Big Lots is kind of iffy here. It’s technically in the retail sector but sells so much in that consumer staples segment that I included it here.
And honestly, shares have been slammed for the better part of two years, down 65% since January 2018, but starting to show signs of a turnaround.
Sales and cash flow have recently improved and the company is in that discount space of retail so is more protected against the death-by-Amazon that we see in other retail stores.
Shares are trading for just 5.4-times earnings. Even with the 5.8% drop in earnings expected over the next year, Big Lots is just 5.7-times earnings.
This company is paying just 30% of its profits out to support that 5.6% dividend yield. This is a small company, just $840 million in market cap and is trading cheap on just about every metric.
Analysts have a low target around $25 and a high of $32 per share which is 48% over the current price. Now like Kraft Heinz, this one could still be volatile and might take a year to realize that turnaround so you might consider using the covered call strategy we talked about recently. That’s an options strategy I use to produce immediate cash return and get near-term protection on some of my stocks.
Our cash flow machine here is Altria Group, ticker MO, with a 7.2% dividend yield.
Shares of Altria have been under pressure for the last couple of years on disappointment over its e-cigarette acquisition Juul but the assets have been written down and it could be ready to trade on a more stable footing.
After the 2008 split, Altria is solely focused on the U.S. cigarette and smokeless market which means it’s much less at risk to the volatile international market. While tobacco use is in decline in the U.S., it’s a very slow rate less than a few percent a year and pricing power keeps sales fairly stable.
One catalyst for the shares, besides the valuation which we’ll get to, is its 10% ownership of Anheuser-Busch which gives it a little growth into that global beverages market.
Shares trade for 11.3-times earnings which are expected higher by almost 5.8% over the next year. This one has fallen well past the point of value and has traded consistently around 13-times earnings which could put it at $57 a share over the next year. In fact, analysts have the shares around $44 on the low end and up to $68 per share at the high end.
Consumer staples stocks aren't cheap right now but there are still some good deals if you look at individual stocks. These could be some of your best investments ahead of a recession and an excellent opportunity for dividend cash yield.