• In times of uncertainty – predictable cash-flow essentials like soap, soda and snacks become popular
• However, be careful to avoid the "safety premium" trap with elite bellwethers
• Two example stocks at the intersection of high quality at a reasonable price in staples

The investment landscape has spent the better part of the last two years intoxicated by the potential returns of hyper-scalers, software, artificial intelligence, and similar assets.

And you can understand why…

These asset-light businesses offered massive free cash flows, unmatched returns on invested capital and strong operating moats.

On the other hand, owning a mundane business like "Proctor & Gamble" simply wasn"t "exciting". 

Earlier this year that thesis was challenged. 

With the broader market starting to challenge the cash burn in the tech space and uncertain future returns – the spotlight shifted.

All of a sudden, money sought refuge from the ephemeral and sought the indestructible.

For example, below is a 20-year chart comparing the performance of Consumer Staples Select Sector SPDR Fund (XLP) vs the S&P 500 (white)

After many years of flat returns – consumer staples have caught a bid – after three years of strong divergence.

In recent years, the divergence was exaggerated due to the outsized weight (and gains) of large-cap tech (which constitute more than 35% of the index).

The question is whether this divergence starts to close?

I think it does.

Soap, Soda and Snacks

Regardless of where the Mag 7 trades – it"s fair to say that (most) people will brush their teeth, wash their clothes and drink coffee. 

Unlike the anticipated need(s) for tools like AI – human needs are very predictable.

This predictability does two things:

1. Creates a floor under revenue and cash flows that cyclical industries simply cannot match.
2. In times of heightened uncertainty – investors start prioritizing the preservation of capital (vs potential returns on capital)

In other words, investors will seek companies with high returns on invested capital (ROIC) and the ability to convert a high percentage of their earnings into cash.

However, when too many investors rush into the same asset class (regardless of the sector) – it creates a "premium"

In this case, it is a safety premium. 

And this can create a trap…

The "Costco Problem": The Quality Trap

I recently performed a deep-dive audit of 103 stocks in the Consumer Staples segment.

The results were telling.

First, my model identifies high quality assets in the sector.

For example, these include (not limited to) Coca-Cola (KO), Walmart (WMT), Costco (COST) and Procter & Gamble (PG) among others.

These companies boast attributes such as strong unit economics, pricing power, and high quality scores (some examples further in this post).

To demonstrate the strength of one business – consider stalwart PG. 

Inclusive of dividends, this soap and toothpaste company has quietly returned investors a total return of ~8%CAGR (which includes an avg 2.6% dividend) for 20+ years: 

The chart works slowly "up and to the right" – giving investors a number of opportunities to buy along the way.

For example, every test of the rising ~5% support line was a chance to buy the stock at a discount (e.g., late last year)

And that"s the thing: 

We want great assets at the right price.

For example, if you overpaid for PG in early 2022 (above the trend channel) – your returns are basically flat over the past four years. 

This is where the discipline of a value-based operating system must kick in.

Now let"s consider the elite "bellwethers" of the consumer staples sector:

• Costco (COST)
• Walmart (WMT), and
• Coca-Cola (KO)

These are three phenomenal businesses (second to none in their sector). They are the definition of durable compounders.

However, the defensive premium being asked today for these names is simply far too high. Consider this: 

• COST – trades at an eye-watering 39x EV/EBIT and 49x P/FCF
• WMT – at 34x EV/EBIT and 66x P/FCF – similar to a tech stock
• KO – at 27x EV/EBIT and 63x P/FCF – far beyond its historical norms

Below is the 20-year chart for KO – which has returned investors a total CAGR of ~9% (inclusive of an average 3% dividend)

Each of these stocks – KO, COST and WMT deserve a permanent place in your portfolio. 

However, the current premium being asked today is irrational.

What"s more, they could stay irrational for many months to come (I don"t pretend to know when a stock will correct).

But at some point – they will mean revert (as the example long-term charts for PG and KO demonstrate).

For example, if we buy a great business like KO at very high multiple, are we:

(a) participating in a sound investment? or
(b) following the herd into a crowded room?

The answer is (b)

Whether it"s "staples or AI" – there has been a tendency for (some) investors to believe that because a stock has been a winner over the past few months – it will remain a winner regardless of the price paid (i.e., recency bias).

For example, paying "40x" cash flow for a soda company or a grocery store – no matter how well-managed, is a path that often leads to disappointing long-term returns.

Separating the Wheat from the Chaff

To help us distinguish a high quality business at the right price – we need a framework.

Below is a brief summary of some (not all) of the quality and valuation metrics I track:

Metric	COST	KO	WMT	PG	PEP	Sector Median
ROIC	14%	14%	10%	14%	10%	7%
OP MARGIN	4%	29%	4%	24%	12%	8%
GROSS MARGIN	13%	62%	25%	51%	54%	36%
INTEREST COVG	73.4x	8.3x	10.7x	49.6x	10.3x	6.7x
EV/EBIT	39.1x	26.9x	34.8x	19.4x	22.7x	16.7x
P/FCF	48.7x	63.3x	65.8x	24.6x	28.7x	16.9x

Doing the work above allows us to identify:

1. What is worth owning (quality)
2. How much we should be willing to pay (valuation)

Applying this framework to 103 staples stocks – I can quickly determine those which are of high quality (where a premium is deserved) and those who are not. 

For example, consider legacy food producers and distributors like United Natural Foods (UNFI) and Bunge (BG).

BG has doubled in price from a year ago. 

And UNFI has rallied from $8 to ~$40 from April 2024. And whilst some investors are very bullish on these names – we also find:

• BG operates on a gross margin of just 4.8% (extremely thin); and
• UNFI carries a debt-to-equity ratio of 2.24x – a very high level of leverage, indicating that the company uses a significant amount of debt to finance its assets.

A weekly chart does not tell us these numbers. It simply shows momentum. 

Momentum will typically dominate price action in the very short-term – however over the long run its earnings and cash flow which determine the price of the asset.

Now as to how I invest – I would be hesitant to take on the structural risk of a low-margin distributor when I can sit tight for a reasonable price on a high-margin brand.

And when we consider that the economy is clearly slowing (not to mention the growing geopolitical and inflationary risks) – the wiser path is to eliminate any companies with high debt loads and limited pricing power (e.g. low margins).

Defining those failure paths is the first step in avoiding permanent capital loss.

Finding Quality and Reasonable Value

The goal of my investment strategy is very simple. Find the intersection of: 

1. High quality; and
2. At a reasonable valuation.

The first part is not difficult – there is no shortage of good companies to invest it. But the more useful exercise is to eliminate those which have structural risks (e.g., poor cash flow, high leverage, low margins, low ROIC or ROE etc)

The second part is far more difficult. 

There are very few high quality businesses at reasonable valuations. 

To help frame this missive further – my audit of 103 names showed two staples worth watching. Let me walk through how I assess these.

#1. MO (Altria)

In full transparency – I own this stock from ~$56 per share – it currently trades ~$66.

Let"s review my quality and value audit:

Category	Metric	Value	Context / Strategic Insight
Quality	FCF Margin	43%	Pure cash hitting the balance sheet.
	Gross Margin	70%	Reflects the unit economics of a genuine monopoly franchise.
	Operating Margin	47%	Extreme efficiency despite declining volumes.
	ROIC	21%	Elite capital efficiency for a non-cyclical asset.
Valuation	P/FCF (TTM)	12.4x	Trading below its 10-year average of 14.8x.
	P/E Ratio	16.2x	Historically consistent multiple for the sector.
	P/OE Ratio	16.2x	Owners" Earnings yield remains highly supportive.
Capital Management	EPS 5Y CAGR	32.6%	Growth driven by aggressive pricing and buybacks.
	Cumulative Share Reduction	14.1%	Significant shareholder return via capital retirement.
	ROIIC (5Y)	0.0	Correct for a terminal-phase firm; all cash is returned, not reinvested.
	Revenue 5Y Growth	+1.2%	The bear case: Stagnant top-line growth is visible and priced in.

A quick word on "Owner Earnings" (OE) as it"s not a metric you will find in popular finance sites. However, it"s one of my favourite metrics to value a stock. 

Warren Buffett introduced Owner Earnings in the 1986 shareholder letter of Berkshire Hathaway as a way to estimate the true cash a business generates for its owners.

Buffett"s definition for OE is as follows:

Reported earnings + depreciation, depletion and amortization − the average annual capital expenditures required to maintain the business"s competitive position and unit volume.

Formula:

• OE = Net Income + D&A − Maintenance CapEx ± Working Capital Changes Owner Earnings
• ** where Maintenance CapEx Capital spending required just to maintain current operations (not growth).

I calculate this for every stock and then determine its Price / Owner Earnings ratio. 

#2. SFM (Sprouts Farmers Markets)

Let"s now walk through a similar exercise for SFM. 

I own this stock from ~$70 per share – currently trades ~$75

Category	Metric	Value	Context / Strategic Insight
Quality	Revenue 10Y CAGR	14.2%	Structural double-digit growth; rare for the grocery sector.
	ROIIC (TTM)	23%	Every $1 invested in new stores returns 23c. Elite compounding.
	EPS 5Y CAGR	26.1%	Earnings power compounding via high-return store expansion.
	ROIC	14%	Solid base level of return on total capital.
Valuation	EV/EBIT	13.3x	Trading at a ~20% discount to 10Y average (16.3x).
	P/FCF	15.9x	Significant discount to 10Y average (20.9x).
	P/E Ratio	14.2x	Reasonable multiple for 25%+ EPS growth.
	P/OE Ratio	15.8x	Strong owners" earnings yield relative to growth profile.
Risks	Cumulative Share Reduction	34.1%	Massive capital return; management is a "cannibal" of its own stock.
	FCF Margin	5%	The Grocer"s Burden: Low margins due to heavy reinvestment.
	Forward Estimates	STALLING	Potential growth deceleration is the primary risk to the multiple.
	Quality Flags	NONE	A "clean" sheet with no accounting or debt trap signals.

One further note re SFM:

• ROIIC at 23% at the current multiple is rare. You"re buying a proven store-rollout machine at a 20% discount to its own history
• Low FCF margin of 5% reflects capital deployment into high-returning stores, which shows up in the 23% ROIIC

These two examples are intended to show you how I assess the intersection of quality vs value. 

Yes, it requires a little bit of work.

But the math involved is high-school level… simple addition and subtraction. 

I compute each of these metrics for the past 10 years – giving me an indication of trends in the business – in addition to how they manage through various business cycles. 

One final note: 

This does not mean rush out and buy these two stocks tomorrow. You can be patient – especially in this environment. They are simply examples of two companies of quality trading at reasonable valuations in this sector. 

Putting it All Together

The move higher in the Consumer Staples sector is supported by both the charts and the macro environment.

However, investors should always be aware of the relative "safety premium" in certain names.

This has meaningfully distorted some of the highest quality names in the segment (e.g., COST, WMT, KO etc)

Yes, these companies are great businesses to own. But it"s far more important to pay the right price. 

We should always resist the urge to buy the "familiar" at any price. That will lead to disappointing long term returns. 

Our checklists (such as those I"ve shared ) are there to guard against over-optimism

For example, the next best use of our capital might be waiting for a better entry point in a high-quality name rather than settling for a low-quality name today.

Regards
Adrian Tout