Consumer Staples Stocks Sport High Yields, But Stay Away For Now
At first glance, buying shares in dominant global consumer staples stocks that have dividend yields of over 3.5% may seem too good to pass up. Such is the case with many household consumer staples companies such as Coca Cola (NYSE: KO), Proctor and Gamble (NYSE: PG) and General Mills (NYSE: GIS). The yields are appealing and over the long-term the companies should fare just fine, but at today’s valuations, investors may be better off taking a pass.
The dividend yields on these companies have gotten so high that investors are willing to pay a premium to own them. In fact, all three companies (KO, PG and GIS) are all trading above their historical average valuations. KO trades at 22.90 times calendar 2018 earnings, PG trades at 21.31 times ’18 earnings, and GIS trades at 17.49 times ’18 earnings. The problem is that consumer staples companies grow at pretty low rates and the 5 year estimated growth rates for KO, PG and GIS are 4.83%, 5.97%, and 6.21% respectively. The fact that these stocks are growing slowly prevents the PE ratio from compressing over time due to growth in Earnings Per Share. Since the stocks are presently trading at historically high valuations, this translates into limited capital appreciation potential.
Another negative that may hurt consumer staples is that there are dominant growth companies to choose from (such as Facebook (NASDAQ: FB) and Alphabet (NASDAQ: GOOGL)) that trade at similar valuations despite having growth rates that are multiples higher. Facebook trades at 25.44 times 2018 earnings with a 25.44% growth rate, and Google trades at 24.53 times ’18 earnings and has a 18.78% growth rate. This dynamic could lead to a rotation out of consumer staples stocks thereby hurting their share prices.
The silver lining is that consumer staples businesses are fairly recession resistant and they own dominant brands which investors are willing to pay a premium for. The stability of their businesses also makes a dividend cut unlikely. So if consumer staples stocks fall another 15-20% from current levels, the combination of even higher yields with a more appealing valuation could create a great long term buying opportunity.
All of the ideas expressed in this article are the opinions of Ideal Asset Management LLC
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