What's The Best Sector For The Long Run?

Buy stock in companies that make things that people need: In today's fast-paced, hyper-focused investment world, it's advice that can seem rather quaint and antiquated. But it's advice that some of history's greatest investors, strategists like Warren Buffett, have used to build incredible track records over the years. And now there's new, hard data and evidence that supports this common sense idea.

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The data comes from quantitative investment guru James O'Shaughnessy, author of What Works On Wall Street and one of the investing greats upon whose writings I base one of my Guru Strategy computer models. In the new updated version of his book, O'Shaughnessy examines how various stock market sectors have performed over more than four decades. Perhaps his most interesting finding: that the consumer staples sector has produced the best returns over that period--and that it's done so while being one of the least risky sectors in the market.

From 1968 through 2009, O'Shaughnessy found that consumer staples averaged compound annual returns of 13.6%, beating the next-best sector (financials) by 1.2 percentage points per year. And, the sector had the second-lowest standard deviation out of the market's 10 sectors; the only one that was less volatile was utilities.

O'Shaughnessy says this is probably a surprise to many, but adds that it shouldn't be, when you think about it. "Industries that make goods and services that people have to buy, regardless of economic circumstances, are bound to do well whatever the economic conditions," he writes. He adds that the sector is also filled with companies that have wide economic moats that protect them against competition, and strong brand recognition--which he says are major advantages for a business.

There's more: O'Shaughnessy also found that looking for the most fundamentally sound stocks within the consumer staples sector could really improve your odds of success. For example, companies in the top quintile based on shareholder yield (buyback yield plus dividend yield) returned 17.8% compounded over the 42-year study. And, they did so with a lower standard deviation and a lower maximum drawdown than the sector as a whole.

O'Shaughnessy's findings got me wondering about which consumer staples stocks currently get the highest marks from my Guru Strategies. Here are some of the best of the bunch, including a couple that my O'Shaughnessy-inspired model rates highly.

Wal-Mart Stores (WMT): This Arkansas-based retail giant sells all sorts of consumer staples at its nearly 10,000 stores, which span 28 countries. It's shown an ability to grow earnings in a range of economic climates, having upped earnings per share in each year of the past decade. In the past year alone it has raked in more than $440 billion in sales.

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Wal-Mart ($200 billion market cap) gets strong interest from my O'Shaughnessy-based growth model. This approach looks for firms that have increased EPS in each year of the past five-year period, which Wal-Mart has done. It also looks for a key combination of variables: a high relative strength, which is a sign the market is embracing the stock, and a low price/sales ratio, which is a sign it hasn't gotten too pricey. Wal-Mart has a solid 12-month relative strength of 72, and its P/S ratio of just 0.46 comes in well below this model's 1.5 upper limit.

USANA Health Sciences (USNA): This Utah-based nutritional and personal care products firm has offerings that range from vitamins to nutrition bars to skin and hair cleansers. It has customers in the U.S., Canada, Australia, New Zealand, Mexico, the U.K., and a number of countries in Asia. Its subsidiary, BabyCare, Ltd., has a direct selling business in China.

USANA ($490 million market cap) gets a 100% score from my Warren Buffett-inspired model. The Buffett approach looks for firms with a decade-long history of upping EPS; manageable debt; and a high return on equity, which is a sign of the "durable competitive advantage" Buffett is known to seek. USANA has upped EPS in all but one year of the past decade, has no long-term debt, and has a 10-year average ROE of 35.2%, which far exceeds the Buffett model's 15% target.

The strategy I base on the writings of hedge fund guru Joel Greenblatt also likes USANA, thanks to the firm's 16.3% earnings yield and 68.4% return on capital.

The TJX Companies (TJX): As the parent of Marshalls, T.J. Maxx, and HomeGoods, TJX offers brand-named clothing and merchandise at discount prices -- making it attractive when times are good or bad. The $24-billion-market-cap firm has taken in about $23 billion in sales in the past year.

TJX's ability to succeed in a variety of economic climates is clear by looking at its earnings history. It has increased EPS in each year of the past decade, one of the reasons that it impresses my Buffett-based model. A couple other reasons: The firm has averaged a 37.1% return on equity over the past ten years, and it has just $785 million in debt vs. more than $1.3 billion in annual earnings. That means it could, if need be, pay off all its debts in less than a year using those earnings, which this model considers exceptional.

My Peter Lynch- and O'Shaughnessy-based models are also high on TJX. The Lynch approach considers it a "fast-grower" -- Lynch's favorite type of investment -- because of its 20.8% long-term EPS growth rate. It likes TJX's 0.88 P/E-to-Growth ratio, and its 24.8% debt/equity ratio. The O'Shaughnessy growth model, meanwhile, likes TJX's history of EPS increases, its relative strength of 91, and its very reasonable 1.05 price/sales ratio.

The Coca-Cola Company (KO): Coca-Cola's size and famous brand name gives it one of the widest moats in the world. The $152-billion-market-cap beverage giant has taken in $46 billion in sales in the past year, and its EPS have declined just once in the past decade (and that was a minor 3% dip in 2008).

Coca-Cola has long been a favorite of Buffett's Berkshire Hathaway , and it currently gets strong interest from my Buffett-based strategy. The model likes its history of increasing EPS in a variety of climates; the fact that its annual earnings ($12.6 billion) are almost as much as its debt ($13.7 billion); and its 30.8% ten-year average return on equity.

Unilever (UN): This Netherlands-based firm makes a variety of home goods and food products, with major brands including Lipton teas, Hellmann's mayonnaise, Dove soaps and shampoos, Slim-Fast, and Vaseline. (Note: Unilever is a dual-listed company, with its sister, ticker symbol UL, based in London.)

Unilever's size ($155 billion market cap, $61 billion in trailing 12-month sales) help make it a favorite of my O'Shaughnessy value model. The strategy also likes the firm's $1.66 in cash flow per share, which is greater than the market mean, and its solid 3.7% dividend yield.

I'm long TJX and KO.