A Guided Tour of the Market 10

Consumer Goods

The consumer goods sector is composed of industries such as food, beverages, household and personal products, and tobacco. Like anything large and old, it also moves slowly: Consumer goods markets typically grow no faster than the gross domestic product and sometimes even slower. Despite this slow growth, consumer goods stocks tend to be solidly profitable, fairly steady performers, which can make them excellent long-term holdings for your portfolio.

Consumer goods companies generate profits the old-fashioned way: They make products and sell them to customers, usually supermarkets, mass merchandisers, warehouse clubs, and convenience stores.

The handful of giant firms that dominate each consumer goods industry enjoy such massive economies of scale that it would be virtually impossible for a small new entrant to catch up.

The networks that manufacturers use to get their products on to shelves in the stores can be another competitive advantage that is very difficult for competitors to replicate.

Companies with brands that hold dominant market share are likely to stay in that position because shifts in share tend to be fairly small from year to year. Thus, whoever is number one right now is likely to remain in that position over the next several years.

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A Guided Tour of the Market 2

Consumer Services

The only way a retailer can earn a wide economic moat is by doing something that keeps consumers shopping at its stores rather than at competitors'. It can do this by offering unique products or low prices. The former method is tough to do on a large scale because unique products rarely remain unique forever.

Because many consumer purchases other than food are discretionary (can be put off for later), it's not surprising that retail stocks generally outperform during periods of economic strength and underperform during times of economic weakness.

Demographic shifts and changes in the workforce make the long-term outlook for restaurants pretty bright. Eating food prepared by restaurants is becoming a more attractive alternative to home meal preparation – with both parents working in many households, there's little time to cook and even less for grocery shopping and cleanup. The economics of meal preparation are shifting in favor of eating out as well because families are getting smaller.

One of the best ways to distinguish excellent retailers from average or below-average ones is to look at their cash conversion cycles. The cash cycle tells us how quickly a firm sells its goods (inventory), how fast it collects payments from customers for the goods (receivables), and how long it can hold on to the goods itself before it has to pay suppliers (payables).

If days in inventory and days in receivables illustrate how well a retailer interacts with customers, days payable outstanding shows how well a retailer negotiates with suppliers. It's also a great gauge for the strength of a retailer.

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Investor's Checklist: Consumer Services

Most consumer services concepts fail in the long run, so any investment in a company in the speculative or aggressive growth stage of the business life cycle needs to be monitored more closely than the average stock investment.

Beware of stocks that have already priced in lofty growth expectations.  You can make money if you get in early enough, but you can also lose your shirt on the stock's rapid downslide.

The sector is rife with low switching costs.  Companies that establish store loyalty or store dependence are very attractive.  Tiffany's is a good example; it faces limited competition in the retail jewelery market.

Make sure to compare inventory and payables turns to determine which retailers are superior operators.  Companies that know what their customers want and how to exploit their negotiating power are more likely to make solid bets in the sector.

Keep an eye on those off-balance sheet obligations.   Many retailers have little or no debt on the books, but their overall financial health might not be that good.

Look for a buying opportunity when a solid company releases poor monthly or quarterly sales numbers.  Many investors overreact to one month's worth of bad same-store sales results, and the reason might just be bad weather or an overly difficult comparison to the prior-year period.  Focus on the fundamentals of the business and not the emotion of the stock.

Companies also tend to move in tandem when news comes out about the economy.  Look for a chance to pick up shares of a great retailer when the entire sector falls - keep that watch list handy.  


Ref:  The Five Rules for Successful Stock Investing by Pat Dorsey


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Investor's Checklist: A Guided Tour of the Market...