Granny’s stocks, widows and orphans stocks, call them what you want. The quest for yield in the face of unprecedented global monetary policies has driven investors of many stripes into multinational consumer equities offering generous dividends.

As populations age across the world, it’s only natural that more investors, especially retirees, are searching for income wherever they can find it. Paltry yields on intermediate government and corporate bonds have even prompted some to proclaim that these stocks might as well be the new bonds.

The mutual fund and ETF industries have responded by rolling out all sorts of vehicles, from equity-income funds to dividend-paying ETFs to low-volatility products. While the names may vary, many of these vehicles own the same identical stocks. Some fear that these equities, which can be found in most mutual funds, index funds, corporate pensions and many of the 75 million 401(k) accounts, are so widely held that a rise in interest rates could cause expected instability in the bond market to infect blue-chip stocks, too.

At a “Women In ETFs” breakfast in late January, Mary Ann Bartels, the chief investment officer in charge of global portfolio solutions at Bank of America/Merrill Lynch, described how she began her typical day—arriving early in the morning and fielding phone calls from European investors looking for high-quality, dividend-paying U.S. equities. Right at that specific time, European investors clearly were trying to profit from the surging dollar.

Less than two months later in late March, the popular Reggie Browne of Cantor Fitzgerald appeared on CNBC on a Friday afternoon to explain the day’s selloff in U.S. equities by noting that American investors, worried about high-priced domestic equities, were selling them to go bargain hunting in Europe.

Neither Bartels’ nor Browne’s observations might seem particularly consequential except that in late March on a Friday, yours truly had lunched with two disciples of the legendary Jean-Marie Eveillard, Charles de Vaulx and Charles de Lardemelle of International Value Advisors. The two Frenchmen, who had closed all their funds to new investors several years ago, had some news for Americans looking for deals in Europe.

Various European indexes might look cheap, they said, particularly those overweighted with heavily regulated, quasi-government-controlled concerns like banks. But investors had already driven up the prices of high-quality European equities beyond levels that met their traditional margin of safety.

Take Nestle, the world’s largest food company, one of the few in its industry still displaying unit volume growth in an era when many European and U.S. food producers are losing share to organic products. De Vaulx and de Lardemelle say Nestle is a great company that they continue to hold in their portfolios. But with shares selling at these levels—17 times Ebitda, up from 8 times in the late 1990s, when there truly was a stock market bubble—they are not buying any more. The fact that Nestle is selling for double what it did during the greatest bubble of the latest hundred years underscores how pandemic the search for yield is today.

Advisors might be forgiven for chalking up the IVA team’s attitude to their strict adherence to a value discipline. But it’s not just value fundamentalists.

Legendary growth-at-a-reasonable-price investor Donald Yacktman of Yacktman Funds has often relied on companies that dominate supermarket and drugstore aisles for impressive returns. For the last 15 years of this century, Yacktman Focused Fund has delivered annual returns of nearly 13% a year, versus about 5% a year for the S&P 500 with a beta of 0.82. That means investors in the index approximately doubled their money in 15 years while those in Yacktman’s fund saw their money increase nearly sixfold.

When interviewed on a panel last November, he listed three of his largest holdings at the time as Coca-Cola, Pepsico and Procter & Gamble. He voiced frustration with his ability to find value anywhere in the U.S. while noting these consumer goods companies at least bring stability to a portfolio.

 

As the current bull market enters its seventh year, it’s not surprising many investors are finding few pockets of value. Many of these blue-chip companies possess enviable records of increasing dividends and often display recession-resistant revenue streams, making them ideal substitutes for yield-hungry retirees and other investors who can’t survive on CDs or other fixed-income vehicles. But do these financial characteristics justify price-to-earnings multiples in the mid-20s or higher?

Bill Fries, managing director and co-portfolio manager of the Thornburg International Value Fund, cites several problems with the consumer staples category, only one of which is valuation. Many of these companies, like Coca-Cola, derive far more than 50% of their revenues of sales abroad. Consequently, the recent surge in the U.S. dollar can dramatically impact their earnings.

Moreover, companies like Nestle, Clorox and Colgate-Palmolive pay out 70% to 75% of their earnings in dividends. If a strong dollar were to cause an earnings drop of 10%, that leaves them with precious little free cash flow beyond debt service and dividend payouts.

No one is arguing that the majority of dividends aren’t sustainable. Most of Granny’s stocks boast high credit ratings, giving them easy access to the corporate bond market where they have unlimited ability to raise capital. In recent years, it has prompted them to engage in financial engineering maneuvers like stock buybacks and dividend increases.

Investors, however, have come to expect dividends that will rise at rates exceeding both consumer staple companies’ revenues and the rate of inflation. One might question whether companies can continue to raise dividends at an attractive pace if interest rates rise and the dollar continues to appreciate.

Steve Yacktman, CIO of Yacktman Funds, explains that the real reason to own the consumer goods companies can be found in the numbers that lie beneath the public metrics like sales and lofty price-to-earnings multiples. Indeed, P/E multiples on companies like Colgate (29 times), Procter & Gamble (25 times) and Pepsi (22 times) don’t reveal the operating leverage and potential for margin expansion inherent in these franchises.

“If you normalize the S&P and look at these businesses’ margins, these stocks are cheap. If you don’t like Pepsi or P&G, you shouldn’t like anything else,” Yacktman contends. “And in 10 years, you won’t ask what went wrong.”

The younger Yacktman concedes that late in a bull market it’s normal for people to start looking for more excitement than soda, detergent and toothpaste. But anyone who is spooked by the sky-high multiples these shares sport isn’t looking under the hood. Unlike industrial companies and other businesses with more cyclical revenues that implemented dramatic restructuring programs during and after the financial crisis, most of these companies have tremendous potential to enhance value by slashing sales, general and administrative costs.

Take Heinz. In the three years since it was acquired by Brazilian private equity firm 3G and Berkshire Hathaway, its operating margins have increased by about 50%, rising from 15% to 23%, according to Yacktman. This explains why Kraft shares jumped nearly 50% after the company agreed to be acquired by Heinz.

In Yacktman’s view, the $3 billion savings in restructuring expenses at Coca-Coca, involving layoffs of nearly 2,000 employees, pale in comparison to the savings ace cost-cutter 3G engineered at Heinz. Two years after 3G and Berkshire bought the company, largely with debt, the value of their equity reportedly has quadrupled.

If the bull market and economic recovery are in the late stages of their life cycles, as some say history would indicate, then consumer staple stocks might offer investors other favorable attributes. “Most people didn’t like consumer stocks in 2006 and 2007,” Yacktman recalls. “When the market collapsed, their input costs fell much more than revenues.”

Even enthusiasts like the Yacktmans concede that entering new markets and achieving superior growth poses a major challenge to these businesses. A company like Nestle, born in 1905 in Switzerland, soon saturated its local markets and launched operations in emerging nations decades before many U.S. competitors looked to the Southern Hemisphere for growth.

For advisors who select their own equities like J. Michael Martin of Financial Advantage Inc. in Columbia, Md., and Naples, Fla., the question of whether to own consumer staples depends more on growth potential than the companies’ current valuations. 

“Europe isn’t growing and America is barely growing,” Martin says. “The bullish story has to depend on whether emerging markets growth takes off.” He isn’t convinced.