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Some corps in consumer sector are glamoured in many books associating to Graham and W. Buffett, I think even some books by Graham falls into this problem. The books I have covered so far have not critically investigated the RISK, tasting more appeal to populism. From history, we know that:

  1. Nifty-Fifty investing did not work (Nifty-Fifty corps from about 1970 to 1996 underperformed S&P by 1%, "Agaist the Gods: the Remarkable Story of Risk" p. 109).
  2. High CF Cons. prod. eq. tends to be characterized by low beta value (non-verified premise). So beta investing is non-sense, more here.
  3. Tom Au -author in the book "A Modern Approach to Graham and Dodd Investing" (book mentioned here) proposed that Grahamian investing or similar is the most profitable after extreme situations such as wars, I cannot remember now the precise phrasing but something similar to that (alert no sources mentioned in the book!). If this is true, I am uncertain whether you can predict this kind of shifts to benefit from the markets.

Is it stupid speculation or not to invest in buffettesque consumer sector (high free CF, non-cyclical, high intrinsic value, etc)?

Helper questions

  1. are the books favorable to winner -philia investing ignorant, particularly underestimating the amount of losers?
  2. Are the risks, for example, in the consumer sector equities underestimated?
  3. Are there more examples such as Nifty-Fifty where people pay for the fact that they are able to associate to the companies?
  4. Is the proposition "to invest in the consumer sector" an epitome of speculation or is there something more into it?
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There is always tremendous risk in investing in an area that you don't understand. If you look at the top money managers of the past century (Buffett, Graham, Fisher, Lynch, Klarman, Miller, etc) the general theme is that they all invested in areas that they understood well. Warren Buffett and Peter Lynch made an entire career out of "own what you understand."

Thus, investing in an area where you have no understanding is a terrible idea and a mistake consistently made by rookies and bandwaggoners.

That being said, the area of non-cyclical consumer products is unique because some of the big names of today (Coke) as well as of the past (Gilette, acquired by Proctor & Gamble) are tremendous brands. Mary Buffett, in the book "Warren Buffett and the Interpretation of Financial Statements discusses companies that have a "Durable Competitive Advantage." Although she discusses various factors, some of the key ones are:

  1. High Gross Profit Margin (over 40%)
  2. Tremendous earnings power
  3. High earnings to debt ratio
  4. Globally recognized brand name

There are many other factors, but those are some of the key ones, especially for the non-cyclical consumer product area since the products are generally low cost so profit is made on volume and breadth of influence.

Like you accurately said, saturation is an issue, but not in the sense you're thinking. Coke has a worldwide presence and there's no way it will grow like it did in the 80s-90s, but it will still be a strong company. Gillette will be solid as long as people need to shave i.e. forever :) Buffett talks about companies with a "moat" - high barriers to entry, competitive advantages. Although coke won't grow as fast as it did, nobody is going to be displacing coke because of the extensive coke network.

Now the question is: how does the investor identify the next Coke and Gillette. First of all, you need to refocus your attention. If you only focus on firms that can maintain high sustainable cash flow be sure to add the "with a positive inflow," because plenty of firms have high cash flow but with more cash flowing out than in!

What you want to go for is firms that have the potential for high sales volume, since the marginal profit compounds into a tremendous cash inflow. If you focus on companies that are already very profitable in the area, you will end up with Coke, Proctor & Gamble, and the like. While they are solid companies, they will not be generating tremendous returns.

Thus, you need to focus on companies that:

  1. Target an area that isn't dominated. Saturation isn't an issue because an excellent firm will beat an average firm, but if there is already a firm in the market that is dominant and growing, then it will be tough to displace.

  2. Target companies with a growing global presence. Unlike some professionals, I believe that America will still be a ground for tremendous growth, but there is also great potential internationally. As the global middle class grows, so does consumption, and that is where the aforementioned industry shines. Look for firms expanding globally.

  3. Brand. In this industry, brand is far more significant than in other areas. If you go to China and you have to pick between China+ Gum (made up) or Wrigley's, which will you take? When product differentiation isn't very strong, brand is what holds up the product. I drink Coke, not Bob's cola. Look for companies with a solid brand or a growing brand.

The obvious risk is that your analysis will be wrong. You find a superior product with an international presence and a growing brand name and three things can happen: 1. It is already strong (i.e. coke) and you make money as Coke continues to dominate or 2. It becomes strong and you become very rich (i.e. Coke investors 40 years ago) or 3. The more likely outcome - it never dominates.

Often times, you will find a strong company that becomes stronger, but very few will ever go on to become the "Coke" of their area. These types of companies grow by sales volume, so it's important to read news, 10-K's, and management reports to see what's going on in the company. It is rare for a company to just become bankrupt or take a sharp loss because the losses are generally gradual, but the astute investor will always be alert for signs of fiscal weakness, which can be a time to leave.

But I cannot stress this enough: you must do your homework. It is literally impossible to find an elite company before it becomes elite unless you do extensive research and analyze the market, see what's happening, and be able to piece it together to select the winners of the next decade(s). Even then, your mileage will vary. Best of luck!

  • I really doubt whether you can find anything like Coca without events such as WW2 and trade innovations. The historical story I outlined there hopefully pointed out the importance of historical events, US and Sweden countries with no war-stricken economy grew about 1% more than the rest of the world after the war. This 1% sounds little but over 70 years, it means that the size of their economies have grown 2 times larger than the rest of the world! Can you find such situations now? If not, where would you look? Sure hard work but look at the general picture, US is now main debtor. – user1770 Jun 23 '11 at 20:56
  • If you look at this site www2.econ.iastate.edu/classes/econ355/choi/rank.htm, then the rate of growth post WW-2 is different from what you suggest. Anyways, companies like Walmart/Costco were founded after WW2 [Walmart was 1962], yet Walmart is the largest by revenue (src: en.wikipedia.org/wiki/List_of_companies_by_revenue). I think WW2 gave Coke an advantage in terms of setting up a distribution system, but after 70 years, other companies have grown well. Even if WW2 hadn't happened, Coke would still have been a tremendous company, even if not that big. – BlackJack Jun 23 '11 at 21:16
  • As for where to look - if its in noncyclical consumer products, I'd look for goods that everyone uses or that everyone will use once they can afford it. Sanitary products are an excellent area as health awareness and wealth increases globally. As for other industries, technology is a tremendous field - look how much Apple, Google, and Microsoft have grown. The opportunity is out there - you have to do your homework :) – BlackJack Jun 23 '11 at 21:18
  • Likewise, look here to chart 1-15 for real equity return and the market age by Professors Philippe Jorion and William Goetzmann. By William Bernstein in the latter link, "[a]s we saw with Venetian prestiti, the highest returns of all were made during the transition from a high-risk to a low-risk environment." -- The businesses we have covered are examples of such environments! They could easily be killed with lost war. I find your homework-teasing more stock-picking than homework, picking out the first google results is not very convincing. – user1770 Jun 23 '11 at 21:34
  • AUpadhyay: Coke is only good to corrode, particularly in emergency situations like here :P Sorry but the question is bloated -- I think much better question would be "Risks with low-beta -valued equity?" and then refine the question to non-cyclical consumer sector. If I am not totally wrong, such firms may be characterized with low beta value -- investigating. What do you think? Currently this is more story-telling business propaganda. Do not take everything in annual letters as truth. – user1770 Jul 1 '11 at 22:35
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Why are you equating Warren Buffet's investment strategy with buying consumer non-cyclicals?

Buffet buys companies that generate cash and/or have the ability to reliably generate cash by market domination or growth. He bought a company a few weeks ago in my area called Sandell Manufacturing, because they dominate the manufacture of certain types of building materials.

Consumer non-cyclicals happen to be companies that reliably generate lots of cash. You get lower returns in bull markets, lower losses in bear markets.

I'm not sure what the actual question is, but if you want to know whether "Is it stupid speculation or not to invest in buffettesque consumer sector (high free CF, non-cyclical, high intrinsic value, etc)?", then the answer is... no. As a sector, it may not be an optimal strategy at a given point in time, but it would rarely be a stupid place to invest.

  • duffbeer703: are there some studies about that consumer non-cyclicals mean "lower losses in bear markets" and "lower returns in bull markets"? I am now uncertain when such companies should be bought: in bulls or in bears? I often avoid such companies to avoid personal bias in investment decision -- and I am not proposing investment -style according to your favorite products, I am very doubtful about such "investing" -- sounds too much like poor nifty-fifty investing. – user1770 Aug 13 '11 at 6:42
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    It is hard to answer your question, because you are making so many assumptions and asking several questions. "Nifty fifty" investing wasn't a failure -- it just demonstrated that investing in the Top-500 companies vs. the Top-50 was a better strategy in that era. I haven't read "The Intelligent Investor" in several years, but IIRC, Graham advocated lots of diversification, including guaranteed investments like US Savings Bonds. Whatever you invest in, the key is to minimize the risks of losing money. – duffbeer703 Aug 14 '11 at 3:46

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