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How to Invest Defensively, Part 3: Consumer Staples

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“Rule number one: Never lose money. Rule number two: Never forget rule number one.” Superinvestor Warren Buffett lives by that advice, and it seems to have worked out well for him. Investing defensively, as Buffett does, is easier said than done, but the right strategies can certainly help you avoid losing money. In the third part of this series, we’ll talk about another area of the market that benefits from inelastic demand – in other words, products that people always need through economic ups and downs.

Consumer staple stocks are easy to understand. After all, you can find most of their products at your local supermarket. The goods they make are so popular and widespread that it’s easy for us to measure how other customers think about them, and to guess from there how those opinions might affect the companies’ overall performance.

And we need consumer staples every day. You might forgo a night out at the movies, expensive jewelry, or a fancy new car if the economy’s suffering, but you won’t go without food or toilet paper. (Then again, this steady demand means that economic boom times don’t necessarily spur customers to buy more consumer staples, either.)

In Hong Kong, consumer staple stocks include HangAn(SEHK: 1044.HK), Vinda(SEHK: 3331.HK), Sasa(SEHK: 178.HK), etc. The sector currently posts a beta – remember, that number measures how volatile a company or sector is compared to the market as a whole – of 0.5, which is slightly higher than the Utilities sector. That may owe to the higher elasticity of supply– the number of alternatives available to consumers. For example, there are at least 5 to 10 tissue brands for customers to choose from, but there’s basically no alternative for electricity supply.

One distinctive advantage of consumer staples stocks is their strong cash flow. The nature of these businesses means their cash flow tends to be stable, so they normally have relatively little leverage and fewer bank loans on their books. That’s another advantage for this sector in times like today, with interest rates rising. And since their target market, consumers, resides at the very end of the supply chain, they tend to have a very minimal amount of accounts receivable, which further benefits their cash flow.

Just remember that consumer staple stocks aren’t invincible, especially in the external environment of Hong Kong. In recent years, a few subsectors within consumer staples have begun to suffer from political pressures and other external factors. For example, Sasa imports and exports cosmetics. A couple of years ago, when mainland China started to allow visitors from the mainland to come to Hong Kong without restrictions on the number of entries, Sasa’s revenue rose drastically as those visitors flooded into its stores in pursuit of its perceived high quality, high-value goods. However, the government has since changed those regulations, restricting visitors’ number of entries, and  Sasa’s sales have suffered accordingly.

That said, I still like the consumer staples sector. So much of what it does and how it works is transparent and visible to every investor, and that has always been my most crucial factor when picking stocks.

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Disclosure: Johnny Chan does not own shares of any companies mentioned. Motley Fool Hong Kong is not licensed by the Hong Kong Securities and Futures Commission to carry out any regulated activities under the Securities and Futures Ordinance.