‘Bread and butter’ stocks – are WOW, WES and others in the staples sector a buy?

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There are only six stocks in the Consumer Staples sector of the ASX 100 – which are listed in the table – and there is only one more stock that makes the top 200 sector – that is, Goodman Fielder. I think all these companies are household names so I’ll not discuss what they do. Perhaps the only one that needs some explanation is Wesfarmers (WES) – let’s refer to it as Coles – as it goes head-to-head with Woolworth’s in its supermarket chain – but ‘Coles’ also has coal and industrial interests!

Sells goods we need, but do we need the stocks?

By its very name, staples, is a sector that produces goods we always need. The bread and butter stocks should not be expected to go through the price cycles that their cousins, Consumer Discretionary, go through – and certainly it’s not a sector that might be expected to swing through the big Resource sector cycles.

Coles and Woolworths are about the same size – as can be seen from the last column of the table. And these two companies account for over 80% of the weight for this sector in the top 200. Both pay reasonable dividends – WOW (4.5%) and WES (5.1%) and both have prices that have run hard over the last 12 months (24.0% and 24.6%).

My views (as is usual) are largely reflected in consensus recommendations. None pass my 2.5 rule – and that failure is more or less peculiar to this sector. Possibly brokers have factored in the recent strong run in prices. The two big guns have recommendations better than 3 (a ‘hold’) – an absolute minimum standard for me to buy in. The other is Metcash – a smaller chain that doesn’t excite me.

To the charts

Turning to Chart 1, I note that the recommendations for WOW and WES slid in recent months. Before that they were OK. And WES looks better now than WOW. Since these recommendations are not bad, the reasonable dividends might be associated with not much growth in capital gains, making a buy seem reasonable – but I’ll now turn to this aspect in detail.

One of the main planks of my investment strategy is our proprietary measure of exuberance – or market mispricing. Often when I write about a particular sector or stock, it seems to be too late or too early to make an important comment. Chart 2 says it all to me – today. And for anyone interested in such charts and more, I update them all each Saturday on www.woodhall.com.au. I think they’re self-explanatory after a brief discussion such as this. I also have a general paper on that site that describes my methodology used in these sector reviews.

From experience, I use +6% overpricing (or exuberance as I prefer to call it) as a trigger for a price correction of about 6% to 10%, or a prolonged sideways movement in price. I have been monitoring these statistics and related methods for more than eight years and I think they have served me very well.

From Chart 2, I note that the Staples sector crossed the ‘magic’ dotted line of 6% on 17 August 2012. At this point the sector price had run hard. Exuberance then fell to around 0% (a buying opportunity?) before rebounding. During this time, the price index for the sector went largely sideways (a bit down) – until about 21 November, when it shot up again. I wouldn’t buy either WOW or WES now (the sector is nearly back to +6% exuberance) but I might have been tempted when it was fairly priced by our measure!

On a personal note – I have never owned a stock from this sector. If I just want dividends I go for Financials. If I just want defensives, I go for Health and Utilities. But I don’t think I am necessarily ‘normal’. We all should make our own choices. I hope this analysis helps you make decisions that are good for you.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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