Consumer Products

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Steve Alexander

The Toy business leads this category, and by a wide margin. The 3 largest U.S. toymakers, Hasbro (HAS), Mattel (MAT), and JAKKS Pacific (JAKK), were all on the screen for significant periods of time. I think this is another illustration of how the Magic Formula does a lot of the work of digging up beaten down sectors for us. The first quarter is generally a weak one for toymakers, as most of their profits come in the Christmas season (as much as 60%).

The original thought was to separate between Consumer Staples (items that we must buy regardless of our financial condition) and Consumer Discretionary (luxury goods). However, many of the industries above would be ambiguous. For example, we need shoes (making them a staple), but in tight times we may decide to buy a store brand instead of more expensive Nike (NKE), adding a measure of discretion to the purchase. Consumer goods companies can make great long term investments - just ask Warren Buffett, whose investments in Coca-Cola, Anheuser-Busch Companies (BUD), and Procter & Gamble Company (PG) are legendary.

Forces affecting the Retail Industry

Brand is unquestionably the strongest form of competitive advantage in Consumer Goods. However, it's important to also judge the durability of the brand. For example, Coke is a brand known around the world, and has endured over 100 years of competition to still enjoy the top spot in the soda category today. That's a durable brand. Compare this to Gap (GPS).Ten years ago, Gap and it's spin off stores Old Navy and Banana Republic were considered fashionable and chic for the all important teen and college set. Today, the store is avoided by those same groups, lest their fashion sense be ridiculed by friends. That's a fickle brand. It's important to be able to separate a fad from a juggernaut. Add this to the PR problems Mattel faced last year with lead paint, and you have an unwanted sector, with some interesting potential investments.

Distribution is also important in the Consumer Goods sector. A company with a wider distribution network can leverage economies of scale to earn more on their fixed costs. An especially attractive arrangement is when one of these companies has an exclusive deal with a large distributor. Take Anheuser-Busch (BUD), for example. While this firm has an incredibly strong brand, they also require exclusivity from distributors. This allows them to lock out competitors like Molson Coors (TAP) and Miller, protecting profit margins. The soda companies also do this well. Have you noticed that McDonald's (MCD) only sells Coke products, while Pizza Hut (Yum! Brands (YUM)) only sells Pepsi? With these exclusive deals, competitors are blocked from those roads of distribution, protecting profits for the established companies.