He appeared on CNBC recently and revealed the results of his analysis. According to O'Shaughnessy, the highest return long-term sector has been consumer staples.
So the sector that has tended to outperform long-term is still frequently described as "defensive".
Many consumer staples stocks are not just "defensive" in nature, though they're frequently described and thought of that way. They can, consistent with their reputation, provide better downside protection than other stocks but, otherwise, calling them "defensive" is actually quite a mischaracterization when viewed over the long haul.
It underestimates their long-term "offensive" potential.
Defensive implies lower risk and lower returns. Well, when it comes to businesses like Coca-Cola (KO) that's half correct. Lower risk certainly, but historically Coke's business has produced above market returns and the company's future prospects aren't exactly dismal.
So consumer staples can be both offensive and defensive, especially the highest quality ones, but, like any stock, still need to be bought at a reasonable valuation level.
They're generally just quality durable businesses that produce high return on capital at relatively low risk (again, especially if bought at the right price).
This CNBC article sum ups some of O'Shaughnessy's analysis.
Here's a couple of his findings:
- Not only did consumer staples do the best among 10 sectors, the highest performing stocks in the consumer staples sector had the highest buybacks plus dividend yield (shareholder yield).
- Those with the highest shareholder yield had an average annual return of 17.8%.
So they have worked very well as an "offense", despite their reputation, and produced above market returns.
Consistent with their reputation, they have also worked as a pretty good "defense".
Higher returns...lower risk.
Over the shorter run -- less than five years or so -- anything can happen as far as price action and relative performance goes, of course (I realize some these days might consider five years longer term). It's over the longer run when the merits become more obvious.
Here's a recent example.
At yesterday's close the S&P 500 was at 1246, down from its pre-financial crisis peak of 1565 hit back in 2007. A 20% drop (excluding dividends).
Now, imagine some unlucky person who happened to put all their money into the SPDR S&P 500 (SPY) on that day (it's generally not wise to commit dollars all at once like that).
So, assuming that person didn't sell, that person's portfolio would unfortunately now be down a little over 20%.
Naturally, that person would be similarly disappointed with portfolio results if, instead he or she happened buy each of the nine Select Sector SPDR ETFs* (Consumer Discretionary XLY, Consumer Staples XLP, Energy XLE, Financial XLF, Healthcare XLV, Industrials XLI, Materials XLB , Technology XLK, Utilities XLU) at their peak prices.
Eight of the nine sectors are, in fact, still below their pre-financial crisis peak. Some much more than others, of course.
The one exception is the consumer staples sector.
So somewhat amazingly, the unlucky individual who bought the Consumer Staples SPDR ETF (XLP) at its very highest pre-crisis price and held it throughout is not underwater and would have collected a very nice dividend**.
The returns from owning the XLP would be positive even if bought at the highest possible price when, nearly 4 years later, the S&P is still 20% below its peak levels. Even if not spectacular absolute performance it's exceptional relative performance.
Now, consider what the results could be with just some disciplined buying of the ETF as stocks were falling and falling during the crisis. Anyone who did that would have a relatively low cost basis and very nice returns these past few years.
Better yet, consider the results if someone was buying the best individual consumer staples stocks as they were getting cheaper and cheaper during that time.
Each sector, of course, went down dramatically during the worst days of the crisis. Most of the sectors were down more than 50% at some point. The best performer, once again, was consumer staples but it still was down for a brief period by a bit more than 30%.
So clearly nothing went unscathed as far as the price action goes. In the short to medium run, any sector will be vulnerable when stock prices are falling across the board.
Yet in the long run, the types of businesses that reside within the consumer staples sector are mostly consistent intrinsic value creators so, while prices can fall in the near term, over time it becomes like trying to hold a beach ball or basketball underwater as the tide rises.
The good news is, unlike the ocean, many of them have a tide that will be rising for a very long time.
Consumer staples have at times in the past few years been anywhere from extremely cheap to attractive.
While not necessarily expensive now, most consumer staples stocks are certainly no longer cheap.***
So there are some great stocks in this sector to own for the long haul but the price paid still matters and the bargains have all but disappeared. Even for very good businesses, what's sensible to buy at a discount to intrinsic value makes little sense at some materially higher valuation.
Finally, if the shares of higher quality businesses did not outperform over the long haul going forward (and they may not, of course), the sheer simplicity of the approach compared to alternatives needs to be considered.
So does the reduced likelihood of permanent capital loss and more narrow range of outcomes.
In fact, if these quality franchises produced merely market returns they'd still win in my book.
The reason is that, if bought well, the same return will have been arguably achieved at less risk of permanent capital loss (not temporary paper losses).
Grantham: What to Buy? - August 2011
Defensive Stocks Revisited - March 2011
KO and JNJ: Defensive Stocks? - January 2011
Altria Outperforms...Again - October 2010
Grantham on Quality Stocks Revisited - July 2010
Friends & Romans - May 2010
Grantham on Quality Stocks - November 2009
Best Performing Mutual Funds - 20 Years - May 2009
Staples vs Cyclicals - April 2009
Best and Worst Performing DJIA Stock - April 2009
Defensive Stocks? - April 2009
* Select Sector SPDRs are ETFs that divide the S&P 500 into nine sectors.
** At roughly 2.7%, Consumer staples as a sector has higher dividends than the S&P 500 so, if you compare returns including dividends, the gap in performance only gets bigger.
*** With any investment, no matter how seemingly attractive, margin of safety is all-important. It protects against the unforeseen real, even if fixable, business problems. Still, it's worth considering this: "If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result." - Charlie Munger at USC Business School in 1994
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