Friday Portfolio Analysis
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As inflation and interest rates started rising last year, folks had to change the way they invested.
Tech companies have reversing course after dominating the market for years, while other sectors like energy had their best year in decades. The S&P 500 Energy sector gained as high as 54% in 2022.
High interest rates allowed banks to earn higher returns last year as well.
However, that all changed when the crypto exchange FTX went under.
Since then, there’s been a growing distrust in the banking sector, which led to crypto bank Silvergate Capital collapsing, followed by Silicon Valley Bank and Signature Bank.
That fallout has sent investors looking for other safe haven investments, and one sector that seems to be gaining traction as we possibly enter a recession is consumer staples.
Consumer staples companies provide products that people need regardless of the economic condition, such as food, beverages, household and personal care products, and tobacco.
These products have inelastic demand, meaning that people will continue to buy them even in tough economic times.
Therefore, companies in the consumer staples sector tend to have a stable revenue stream and are less affected by economic downturns.
Additionally, these companies are often referred to as “defensive” stocks because they are less sensitive to market fluctuations than other sectors such as technology.
All these factors are leading investors to be more inclined towards having more exposure to consumer staples names in their portfolios.
That is why, today, we’ll take a look at The Consumer Staples Select Sector SPDR Fund using Uniform Accounting and evaluate the top holdings of the ETF.
Let’s see the fund’s top holdings and evaluate if it can prove that its consumer staple holdings are profitable.
Economic productivity is massively misunderstood on Wall Street. This is reflected by the 130+ distortions in the Generally Accepted Accounting Principles (GAAP) that make as-reported results poor representations of real economic productivity.
These distortions include the poor capitalization of R&D, the use of goodwill and intangibles to inflate a company’s asset base, a poor understanding of one-off expense line items, as well as flawed acquisition accounting.
It’s no surprise that once many of these distortions are accounted for, it becomes apparent which companies are in real robust profitability and which may not be as strong of an investment.
See for yourself below.
Looking at as-reported accounting numbers, investors would think that investing in The Consumer Staples Select Sector SPDR Fund was a mistake.
On an as-reported basis, many of the companies in the fund are poor performers. The average as-reported ROA for the top 15 holdings of the fund is 9%, which is below the U.S. corporate average.
However, once we make Uniform Accounting adjustments to accurately calculate the earning power, we can see that the average return in The Consumer Staples Select Sector SPDR Fund’s top 15 holdings is actually 31%.
As the distortions from as-reported accounting are removed, we can see that The Coca-Cola Company (KO) isn’t an 8% return business. Its Uniform ROA is 59%.
Meanwhile, Philip Morris International (PM) looks like a 15% return business, but this massive tobacco company actually powers a 63% Uniform ROA.
To find companies that can deliver alpha beyond the market, just finding companies where as-reported metrics misrepresent a company’s real profitability is insufficient.
To really generate alpha, any investor also needs to identify where the market is significantly undervaluing the company’s potential.
These dislocations demonstrate that most of these firms are in a different financial position than GAAP may make their books appear. But there is another crucial step in the search for alpha. Investors need to also find companies that are performing better than their valuations imply.
Valens has built a systematic process called Embedded Expectations Analysis to help investors get a sense of the future performance already baked into a company’s current stock price. Take a look:
This chart shows four interesting data points:
- The average Uniform ROA among The Consumer Staples Select Sector SPDR Fund’s top 15 holdings is actually 31% which is much better than the corporate average in the United States.
- The analyst-expected Uniform ROA represents what ROA is forecasted to do over the next two years. To get the ROA value, we take consensus Wall Street estimates and convert them to the Uniform Accounting framework.
- The market-implied Uniform ROA is what the market thinks Uniform ROA is going to be in the three years following the analyst expectations, which for most companies here are 2023, 2024, and 2025. Here, we show the sort of economic productivity a company needs to achieve to justify its current stock price.
- The Uniform P/E is our measure of how expensive a company is relative to its Uniform earnings. For reference, the average Uniform P/E across the investing universe is roughly 20x.
Embedded Expectations Analysis of The Consumer Staples Select Sector SPDR Fund paints a clear picture. Over the next few years, Wall Street analysts expect the companies in the fund to slightly increase in profitability, while the market is more optimistic and thinks that the returns will increase further.
Analysts forecast the portfolio holdings on average to see Uniform ROA improve to 32% over the next two years. At current valuations, the market’s expectations are higher than analysts and it expects a 48% Uniform ROA for the companies in the portfolio.
For instance, Costco Wholesale Corporation (COST) returned 17% this year. Analysts think its returns will increase slightly to 18%. And at a 32.1x Uniform P/E, the market expects profitability to rise further and is pricing Uniform ROA to be around 27%.
Similarly, Colgate-Palmolive Company’s (CL) Uniform ROA is 26%. Analysts expect its returns will increase to 29%, but the market has more optimistic views on the company and pricing its returns to be around 38%.
Overall, The Consumer Staples Select Sector SPDR Fund has high-quality names in its portfolio and names that people would want to be exposed to while investing in the consumer staples sector. However, the market’s expectations for these names are really high, and that limits the upside potential.
For investors who would want to focus on protecting their portfolio rather than focusing on high returns, The Consumer Staples Select Sector SPDR Fund might be a good place. But it’s important to note that investors should be very careful in these times and analyze the current market expectations and valuations of these companies in a highly detailed way.
This just goes to show the importance of valuation in the investing process. Finding a company with strong profitability and growth is only half of the process. The other, just as important part, is attaching reasonable valuations to the companies and understanding which have upside which has not been fully priced into their current prices.
To see a list of companies that have great performance and stability also at attractive valuations, the Valens Conviction Long Idea List is the place to look. The conviction list is powered by the Valens database, which offers access to full Uniform Accounting metrics for thousands of companies.
Click here to get access.
Read on to see a detailed tearsheet of one of The Consumer Staples Select Sector SPDR Fund’s largest holdings.
SUMMARY and PepsiCo, Inc. Tearsheet
As one of The Consumer Staples Select Sector SPDR Fund’s largest individual stock holdings, we’re highlighting PepsiCo, Inc. (PEP:USA) tearsheet today.
As the Uniform Accounting tearsheet for PepsiCo, Inc. highlights, its Uniform P/E trades at 31.6x, which is above the global corporate average of 18.4x, but around its historical average of 31.0x.
High P/Es require high EPS growth to sustain them. In the case of PepsiCo, Inc., the company has recently shown 28% Uniform EPS growth.
Wall Street analysts provide stock and valuation recommendations that, in general, provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, PepsiCo, Inc.’s Wall Street analyst-driven forecast is for EPS to be immaterial in 2023 and grow by 7% in 2024.
Furthermore, the company’s return on assets was 20% in 2022, which is 3x the long-run corporate averages. Also, cash flows and cash on hand consistently exceed its total obligations—including debt maturities and CAPEX maintenance. Moreover, its intrinsic credit risk is 60bps above the risk-free rate. Together, these signal low dividend risks and low credit risks.
Lastly, PepsiCo, Inc.’s Uniform earnings growth is in line with peer averages, and in line with peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research
This portfolio analysis highlights the same insights we share with our FA Alpha Members. To find out more, visit our website.