With equity markets trading close to their all-time highs it would be easy to assume that most stocks in the S&P 500 are experiencing a similar performance. After all, the index represents the market, right? In our opinion, we are approaching a new phase of the current equity market cycle. What follows are a few observations that characterize this new phase:
- Companies that have built shareholder wealth on “brand value” are having difficulty competing in a world where white label (especially in consumer products) is increasingly sought after.
- Companies generating little to no innovation in products are experiencing a much-deserved valuation adjustment.
- The potential negatives of corporate acquisitions are starting to show through. Management teams that cannot deliver on announced goals are seeing dramatic adjustments share price. Contrary to popular belief, not all acquisitions are beneficial.
These are just a few examples (of many) that need to be recognized when looking at equity investments in the current environment. By no means are the companies depicted above unique. To the contrary, there are many more we could show.
This brings us to the key concept of this article: investments that have the perception of being “safe” can no longer be relied upon as such. In large part, I’m referring to consumer staples businesses. These are companies that sell household consumer products, that advertise heavily to build brand value, and that have been relative outperformers when equity market conditions became difficult.
In our opinion, successful equity investing in the future will require an adjustment in thinking about what is safe and unsafe. We are not alone in recognizing this subtle shift in mentality. For those who have been following the annual Berkshire Hathaway meeting (held over the weekend of May 5th), the Oracle of Omaha highlights as much in the various comments he’s made throughout the conference. In summary, Warren Buffett indicated that applying traditional “value” strategies once used early in his investing career would likely not result in the same positive outcomes today for a variety of reasons. He goes on to say that value oriented investors need to remain vigilant against investing in “yesterday’s moats” (i.e., competitive advantage that is eroding). With the pace of competitive dynamics quickening, ensuring company management teams evolve with the times is imperative.
Another insight we take away from the three points above is that intangible assets are less valuable than once thought. Take brand value for example. Some companies like Coca-Cola and Clorox have spent decades and hundreds of millions of dollars on advertising to establish a positive brand image. Brand value is becoming less relevant in an era where (1) consumer purchases are increasingly migrating online, (2) retailers like Whole Foods Market/Amazon, Costco, and Kroger are placing an emphasis on private-label products versus branded products, and (3) stagnation in wage growth is driving consumer demand for lower-priced private label products.
In all, this article is not meant to be a call to action for our clients/investors to dump shares in consumer staples. Instead, we draw a comparison between investing based on (potentially hazardous) rules of thumb and legitimate opportunities in the marketplace. As we’ve always indicated, there’s no such thing as a “forever” stock. We evaluate companies and their competitive positions at regular intervals to solidify our understanding of each position we own in our portfolio. As you might expect, this takes a significant amount of time and effort. We feel this knowledge will translate into a significant benefit if/when equity markets turn decidedly lower. Until that time, we will keep our eyes open for new opportunities that may not fit within historical definitions, and we will be on alert for potential value traps.
Gratus Capital is an SEC-registered investment advisor. Registration with the SEC does not imply any level of skill or training. Our ADV documents are available upon request. The opinions expressed are as of May 2018 and may change as economic conditions vary. The information provided is not intended to be relied upon as specific investment advice and is not a recommendation, offer or solicitation to buy or sell any securities. No graph or chart by itself can be used to determine which securities to buy or sell, or when to buy or sell them. As with any investments, past performance is not a guarantee of future results. There is no guarantee that any investment strategy will achieve its objectives, generate profits or avoid losses.