Two Mouth-Watering Food Stocks

03/21/2011 1:15 pm EST

Focus: STOCKS

Richard Band

Editor, Profitable Investing

These staples of successful investing will comfortably outperform the market in the long run, writes Richard Band, editor of Profitable Investing.  

I still believe there’s room for the US stock market to move higher from here over the next few quarters. Indeed, I’ve boosted my year-end target range for the S&P 500 index to the 1,385-to-1,435 range, from 1,300 to 1,350 previously.

At the midpoint of the range, the market would sell for about 15 times this year’s estimated operating earnings—about as high a price as I can envision a reasonable buyer paying for a diversified basket of stocks under current economic conditions.

However, I also recognize that solid values are much harder to find at these levels. According to a formula developed by the late Prof. James Tobin of Yale, called the Q-ratio, US stocks as a group are trading at about a 17% premium to the replacement cost of the companies’ assets.

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That’s higher than at the famous 1929 market top, as well as any point in the past century except for the last few years of the Internet bubble. If there was ever a time to insist on owning stocks that are safe and cheap, now would appear to be it.

“Safe” to me means that a company’s fundamental business model—including its financial structure—is strong enough to endure the lashing of a severe economic storm. A safe stock will hand my money back, intact, after a reasonable holding period.

“Cheap” goes a step further. For sure, a stock that is cheap by some measure of intrinsic value (earnings, dividends, cash flow, book value, takeover value, etc.) should preserve my capital. But it should also grow my wealth a good deal faster than inflation and taxes can take it away. Cheap stocks deserve to be priced substantially higher than they are.

Next: Look for the Bare Necessities

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Look for the Bare Necessities
What’s safe and cheap in today’s market? As it happens, many of the best candidates seem to be concentrated among businesses that supply what Satchmo Armstrong used to call “the bare necessities of life.” Food and beverages, especially, as well as other household goods.

At the moment, Wall Street isn’t paying much attention to these staples stocks. They’re quietly sitting on the shelf, churning out steadily higher sales and profits, and throwing off good dividends.

When the market catches its next whiff of fear, though (for whatever reason), you can be sure investors will come running back to the staples. We want to be there, ready to welcome the crowd home.

Here are two of my favorite buys as we speak, each with the potential to rack up a total return (price gain plus dividends) of at least 15% in the coming year:

Nestle (OTC: NSRGY): The envy of every other processed-food maker in the world, Swiss-based Nestle boasts top-of-class manufacturing and marketing, as well as a widely diversified product line: from chocolates and cocoa to milk products (including ice cream), juices, coffees and teas, pasta, seasonings. and frozen entrees.

The stock, a true long-distance thoroughbred, has more than doubled in the past ten years, compared with a miserly 12% increase in the Dow.

However, Nestle finds itself today about 5% below its December peak. You’re getting a rare discount on a premium franchise. Current yield is 3.1%.

Pepsico (PEP): More than just an all-American soft-drink company, Pepsico also produces snacks (Lays, Doritos) and breakfast cereal (Quaker Oats.)

Like most food makers, Pepsico has faced a margin squeeze lately, thanks to the steep run-up in commodity prices. Eventually, however, I’m confident Pepsico will manage to do what it has done ever since 1898—raise prices enough on its finished products to recoup input costs.

Meanwhile, at 14 times estimated 2011 earnings, the shares are trading 35% below the valuation at the October 2007 market top. Pepsico also yields 3%, half again as much as the S&P 500, with a record of 38 annual dividend increases in a row.

A stock this cheap should easily outpace the broad market indexes over the next ten years—just as it has done over the past ten.

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