Most consumer goods companies fall into one of two camps: cyclical or defensive. The former, of course, indicates that the goods that the company sells are either not necessary or are a luxury purchase which can be avoided during challenging economic periods. The latter, meanwhile, are day-to-day items which are required and people could not do without.
Clearly, companies focused on necessity products such as food and clothing are likely to offer more stable financial performance than their cyclical peers. However, at the same time, cyclical companies can offer more upside in the long run – as long as you are able to stomach above-average volatility. Therefore, a mix of the two can prove to be a prudent and logical way forward for Foolish investors.
Cyclicals
With the UK economy continuing to go from strength to strength, cyclical consumer goods companies such as furniture seller, DFS (LSE: DFS), and Express Gifts owner, Findel (LSE: FDL), are on the up. Both companies are forecast to increase their earnings at a rapid rate, with DFS’s bottom line set to rise by 16% next year and Findel’s by as much as 21% in the current year. Clearly, such strong growth rates could act as positive catalysts on the share prices of the two companies, since they are at least double the growth rate of the wider index.
Despite this, both DFS and Findel trade on low valuation multiples, which indicate that they offer wide margins of safety. This appears to swing the risk/reward ratio in the investor’s favour, with DFS having a price to earnings growth (PEG) ratio of just 0.8 and Findel’s being even lower at 0.4. As such, and while they are cyclical businesses, they appear to be worth buying at the present time.
Defensives
Meanwhile, Unilever (LSE: ULVR) (NYSE: UL.US) and Morrisons (LSE: MRW) are far more defensive than DFS or Findel. In Unilever’s case, its defensive sales profile comes via the strength of its brands, since there are cheaper shampoos and other personal care products available.
However, even during challenging periods for the global economy, Unilever continues to command relatively high margins and, with over half of its revenue being derived from emerging markets, its growth rate is also very appealing. In fact, Unilever is set to grow its top line by 4.7% next year and, with cost savings and efficiencies to come through, its bottom line growth should be higher and could catalyse investor sentiment.
Of course, the sale of food is defensive since it is a necessity for all individuals. However, the pressure on household budgets in recent years has meant that many consumers have traded down to discount, no-frills operators such as Aldi and Lidl. This has meant that supermarkets such as Morrisons have lost out, with the company’s sales stagnating in the last five years, with heavy discounting and promotional offers causing margins to be squeezed heavily.
As such, Morrisons has made a loss in each of the last two years but, in the current year, it is expected to turn this around to post a profit of £377m on a pretax basis. And, with growth of 20% expected for next year, it could prove to be a surprisingly strong performer over the medium term – especially since it has a price to earnings (P/E) ratio of 15.6.