Consumer Staples Sector Is Pricey, but Opportunities Remain

The Consumer Staples Select SPDR (NYSEArca: XLP), the largest ETF dedicated to that sector, jumped 27.4% last year, an admirable performance for a low beta group in a year in which equities rallied.

The downside of upside in defensive sectors, including consumer staples, is that lofty valuations often ensue and some analysts view that as the current condition facing staples stocks, but that doesn’t XLP is at a loss for the opportunity.

“When taken together, we view the consumer defensive sector as overvalued, with the median stock trading at an 8% premium to our fair value estimates,” said Morningstar in a recent note. “Within the sector, we consider retail defensive overvalued, trading at a 20% premium to our assessment of intrinsic value. However, we see opportunities in tobacco and alcoholic beverages, which in the aggregate trade 14% and 10%, respectively, below our valuations.”

Consumer staples are those items that appear in our cupboards and closets, from shaving cream to soda. These items cover many everyday items and consumer goods that will continue to see demand regardless of the economic situation. For investors looking to get involved with this sector, the Consumer Staples Select Sector SPDR ETF (XLP) is one option to gain broad exposure to this defensive play.

Evaluating XLP

Expanding digital footprints by some consumer staples companies, including XLP top 10 holding Walmart (NYSE: WMT), could be an important longer-ranging catalyst for the fund.

“We think the digital channel remains an area of opportunity for consumer goods firms, as e-commerce penetration has been steadily increasing over the past decade,” according to Morningstar. “Retail spending through e-commerce grew 17.3% for the third quarter of 2019, far surpassing the 4.4% growth in total retail spending (Exhibit 3). While this channel has helped lower the barriers to entry for niche competitors, particularly by reducing the need to secure shelf space at brick-and-mortar retailers, firms that keep investing in their brands should be able to defend against competition, both in-store and online.”

The consumer staples segment has long been viewed as a high-quality and defensive play. The slow and steady nature of the consumer staples business has long been touted as a safe play for all periods since consumers will still need to buy the basic necessities.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.