Companies you should consider as the backbone of a diversified dividend stock portfolio
If I had to write a list containing fifty rock solid businesses with
- a highly profitable and durable business model,
- a broad economic moat on the basis of iconic brands,
- an excellent track record of superior cash generation,
- sound financial fundamentals,
- a compelling dividend history,
- several robust catalysts for future growth
and therefore perfectly suited to be a core holding of a conservative dividend growth investor to build intergenerational wealth, at least half of them would be the big names of the consumer staples sector, especially following businesses:
- J.M. Smucker
- The Heineken Company
- Anheuser Bush
- The Coca Cola Company
- Mac Donalds
- Procter & Gamble
Stocks of such wonderful businesses truly are for life. These are shares you don’t have to babysit.
Just take care you get a nice entry point making a good margin of safety, hold on to the company through thick and thin and reinvest the dividends.
Build on Great Brands
Leading companies operating in the coffee-, chocolate-, tobacco-, spirits-, beer-, and sparkling lemonade business have been tremendously successful for more than a century.
Their products are not going anywhere.
Let’s take the British spirits and beer producer Diageo for example, owner of a superior portfolio with iconic brands amongst them big names such as
- Guiness Beer,
- Johnnie Walker,
- Baileys and
- Captain Morgan.
Do you see one of these names disappear anytime soon?
Or do you know many restaurants not offering at least one beverage of Coca Cola, PepsiCo or Nestlé?
I cannot remember having gone through a supermarket without having bought or seen at least one of Unilever’s refreshments (Lipton Ice Tea, ice cream like Ben & Jerry’s and Magnum just to name some of them) or some of its home and personal care products such as Omo, Coral, Cif, Dove, Axe, Rexona, Dusch Das or Signal.
The same goes for the iconic brands of the other companies I named above.
These are excellent businesses with the ability to create value for shareholders. They have high profit margins because of their unique market position and their exceptionally strong brand portfolio.
Consumer staples companies don’t require heavy investments in order to keep their profitability
I just had a conversation with a good friend of mine who started investing in 2015, in the midst of the “commodity price crash”. It was a terrific time for everyone who wanted to take exposure in mining stocks such as Glencore, BHP Billiton, Rio Tinto, Anglo American or oil producer such as Royal Dutch Shell, Chevron or Exxon Mobil.
Having acquired stocks of Chevron for USD 85 per share (its price now lies slightly above USD 130) or Rio Tinto for GBP 18 (it now sits at around GBP 40) has been a particularly good move, benefitting of Yield on Costs of well above 5 %. As we all know, commodity prices have recovered quite nicely, These companies have optimised their cost structures and slashed their capital spendings. Their cash generation has improved significantly.
So, there is a lot to like about such businesses. But the “commodity crash” also revealed the weakness of their business models which inherently rely on one factor on which such companies cannot have an influence on: the PRICE of the commodities. They are price-takers.
So, these businesses are extremely cyclical and there is another factor which always has to be considered: mining companies and oil buisnesses have to invest heavily, just to hold their output even.
Things can turn very ugly during recessions or when there is a severe over-supply leading to plummeting prices.
Or just look at the car industry which is very cyclical and extremely capital intense and highly leveraged; even such a huge company like General Motors went broke during the Big Recession.
Don’t get me wrong: cyclical companies have their place in a diversified stock portfolio, they get dirt cheap from time to time and can make terrific investments even for the longer term. But don’t focus too heavily on them and keep an eye on their sector.
So, when you want to build a dividend income machine generating an ever growing passive income stream, cyclical businesses acquired at a nice Price have their place, but make sure your BACKBONE INVESTMENTS include some rock solid CONSUMER STAPLE STOCKS.
A broad economic moat built over decades
What are the characteristics of companies such as Procter & Gamble, Unilever, Nestlé, CocaCola or PepsiCo?
They sell their products over and over again. Over a billion of customers buy food and home care products from Unilever each day.
And here comes the best: they don’t have to reinvent their products.
Heineken beer for instance has been the same for more than a century. The company could focus their resources on marketing the product. These businesses could build a reputation, a brand.
Excess cash flow could have been invested heavily into bolt-on acquisitions. Just think of that: The Heineken Company owns around 250 beer companies.
The products of the Heineken Company (beer & cidre) are simple and remain the same. They have to remain the same.
When an enterprise sells the same product for generations, it has the possibility to build an extremely powerful brand portfolio which is the basis for its economic moat.
And with constantly rising sales there comes another important factor: economies of scales. Unit production costs sink which supports margin expansions enabling the companies to pay and increase dividend payments to their shareholder each year.
But stocks of high quality consumer staple companies NEVER get cheap, do they?
It is very rare that shares of businesses such as Hershey or Nestlé get really cheap.
Of course not, intelligent investors know the quality of such companies. But from time to time, stock prices of wonderful companies get very attractive.
So embrace stock market corrections as they provide rare opportunities to acquire stocks of a great business at a much more attractive price.
But even then, you have to pay a kind of price premium. And what you get is value: pieces of a high quality business, stability and dividend growth.
Just make sure that you don’t overpay and you really get rewarded to hold onto such stocks. Wonderful things can happen to the patient investor.
Just take Nestlé for instance, having increased its dividends for decades. It made generations of shareholders a fortune.
In 2009, when I acquired Nestlé stocks for a price of around CHF 30, the company paid out a dividend of CHF 1.60 per share. In 2017, the company distributed CHF 2.30 per stock. The dividend yield at costs of my investment has increased handsomely to almost 5 % (the Swiss withholding tax on dividends is 35 %, if there is a double taxation treaty with the country of the investor, twenty percentage points can be reimbursed to that investor to lower the tax rate to 15 %).
That’s why I just love chocolate, coffee and ice cream – to consume and even more to invest in.
But even companies such as Coca Cola have their problems, don’t they?
You will never ever find a company never having to undergo tough times or periods of slowing growth with decreasing profits. That’s life and no reason to lament about – or even worse – a reason to sell a stock.
As long as the fundamentals show no sign of severe deterioration, the economic moat of the business is still intact and the compay churns out plenty of cash, I am more than happy to keep my stocks.
There is a great thing with consumer staple companies: not only are they tremendously resilient with regard to recessions or “shocks”, they also can survive a lot of things better than most other companies. Not only do they survive, they even thrive. Just look at the biggest five players in the tobacco industry. Their sales have been stagnant (at best) over the last decades and yet they showed an extraordinary performance. In contrast, General Motors went broke amid stagnant or falling revenues.
With consumer staples, it’s not like commodity businesses which can litterally end up destroyed just because the Price of one particular good has fallen significantly. Or just look at banks, obsessed by their short term profit thinking destroying themselves.
Companies such as Nestlé and Coca Cola are certainly not immune against slowing growth or even falling profitability, but as said: many great things can happen to a patient shareholder.
I wouldn’t be too surprised when a long-term investor in Nestlé would see some take-overs, maybe even one or two spin-offs and most important: a lot of dividends paid out to a shareholder willing to sit on the stocks for decades.
Just remain invested in wonderful companies
Nestlé and such kind of businesses give stability to a portfolio and provide a steadily increasing stream of fresh cash ready to be invested.
Their core business doesn’t degrade and it is very likely that these companies will be even larger in the future.
Just take a long term view and the compound effect will work in your favour.
You will end up with a wonderful stock portfolio which will thrive BECAUSE you are DOING NOTHING else than collecting all the dividends and reinvesting that cash.
You are responsible for your own investment and financial decisions. This article is not, and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action.