7 Smart Investments in Consumer Staples

How bad would things have to get before you stopped putting ketchup on your fries? Before you stopped eating fries -- or washing them down with a soft drink, for that matter? What kind of Armageddon would keep you from buying toilet paper, diapers or detergent?

If you can’t imagine life without the products in your pantry, linen closet or laundry room, then you know why shares of com­panies that make consumer necessities have performed well, even in a dicey economy. In 2011, Standard & Poor’s 500-stock index returned a mere 2.1%, but consumer-staples stocks in the index gained 7.5%.

Will staples deliver again this year? In light of some recent positive data, some advisers are casting an eye toward stocks that do better in an improving economy. But staples provide the defensive ballast that portfolios still need in uncer­tain times like these. Sam Stovall, a strategist at Standard & Poor’s Capital IQ, recommends an outsize position in both economy-sensitive stocks and staples: “If the market really takes off, then industrials and materials will be better performers. But if we continue in this sideways market, it’s good to have a hedge.”

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Moreover, S&P sees staples firms delivering better earnings growth this year than the typical U.S. firm (it sees 9.3% profit growth for staples, while analysts on average expect S&P 500 profits to rise 6%). And the staples sector yields 3.1%, compared with 2.3% for the S&P 500 and 1.9% for ten-year Treasury bonds. Many staples producers operate globally and are well-positioned to benefit from rapidly growing wealth in emerging nations. Plus, rising materials costs for household-goods makers and food processors should moderate this year—easing pressure on profit margins.

Exchange-traded funds are a low-cost way to invest in staples, delivering ex­posure to a number of com­panies on the cheap. Consumer Staples Select Sector SPDR (symbol XLP) charges 0.20% of assets per year for expenses. Vanguard Consumer Staples ETF (VDC) charges even less, just 0.19%. Both funds hold roughly 20% of assets in retailers, such as Wal-Mart Stores and CVS Caremark, that derive significant revenues from groceries or from essential drugstore items. The Vanguard and SPDR ETFs each returned 11% in 2011.

If you prefer active management, consider Yacktman Fund (YACKX), which holds a fair share of staples. “Why would anyone want to own a Treasury bond when you can get Pepsi with a dividend that grew 7% last year?” asks co-manager Donald Yacktman. Jensen Quality Growth I (JENIX) is also a good choice.

If you favor individual stocks, look for companies with a strong product mix and a record of innovation. General Mills (GIS) is a good example (chocolate Cheerios, anyone?). It recently bought a controlling interest in the Yoplait yogurt business. The stock, about one-third as volatile as the market overall, trades at $40, or 15 times year-ahead estimated earnings (prices are through January 6). Procter & Gamble (PG) is the quintessential staples company, with more than 20 billion-dollar brands, including Tide, Charmin and Gillette. Since 2001, P&G has doubled its sales from emerging nations. At $66, the stock sells at 15 times estimated year-ahead earnings.

H.J. Heinz (HNZ) makes not only ketchup but also the Ore-Ida French fries and Tater Tots to squirt it on and Weight Watchers dinners to help take off the pounds afterward. The king of condiments has been buying firms in em­erging markets while managing higher tomato costs by shrinking packaging without cutting prices. At $53, the stock yields a tasty 3.6%.