Consumers need staples, but not the stocks
After a strong 2013, the sector now looks overvalued and is lagging.
Usually a beacon of predictability and stability, particularly in volatile market environments, the consumer staples sector thrived in 2012. The bad news is not only has the group been lagging the broader market for a couple of months now, it is also richly valued.
In downgrading his view of the sector to "neutral" from "overweight," iShares Global Chief Investment Strategist Russ Koesterich calls the premium staples stocks currently trade at "extreme."
"As people generally need to buy household items like toothpaste and soap even when the economy is weak, consumer staples stocks typically trade at a premium due to the stability of their earnings streams," wrote Koesterich in a note. "But today's premium looks extreme. Consumer staples is now the most expensive sector globally, trading at 3.4 times price to book, nearly double the level of the global benchmark."
Adding to the potential disappointments for investors embracing staples stocks and exchange-traded funds (ETFs) at currently frothy levels is earnings growth. As in estimates for staples' earnings growth do not jibe with the lofty valuations the sector now sports.
"Despite their rich valuation, earnings growth estimates for the sector are the third lowest of the 10 economic sectors," wrote Koesterich.
Staples stocks are prized for low betas, dependable dividends and predictable earnings, but even with those favorable catalysts, the statistics support Koesterich's view that the group is richly valued.
Take the Consumer Staples Select Sector SPDR (XLP). With over $5.6 billion in assets under management, XLP is the largest staples ETF by that metric. An ETF that devotes 42% of its combined weight to stodgy Procter & Gamble (PG), Philip Morris (PM), Coca-Cola (KO) and Wal-Mart (WMT) trades with a price-to-earnings (P/E) ratio of almost 17 and a price-to-book value of 3.33, according to State Street data.
Conversely, the Technology Select Sector SPDR (XLK), an ETF that allocates almost 23% of its combined weight to Apple (AAPL) and Google (GOOG), has a P/E ratio of just over 13, according to State Street.
Pricey staples names are not just a U.S. phenomenon. The iShares S&P Global Consumer Staples Sector Index Fund (KXI) devotes almost half its weight to companies that are not based in the U.S., including Nestle (NSRGY), British American Tobacco and Diageo (DEO).
While KXI keeps with the staples tradition of being a low-beta offering (beta of 0.63), the ETF is another example of a richly value staples play. For the privilege of owning the aforementioned international stocks along with Procter & Gamble, PepsiCo (PEP) and Altria (MO), among others, investors will have to deal with KXI's P/E ratio of almost 20 and a price-to-book ratio of 5.86.
That is pricier than the iShares S&P Global Technology Sector Index Fund (IXN), where Apple and Google combine for over 20%, and the iShares S&P Global Energy Sector Index Fund (IXC). Koesterich has "overweight" ratings on the global energy and technology sectors.
For more on ETFs, see here.
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