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6 stocks that let you sleep at night

Susan Dziubinski  |  10 May 2021Text size  Decrease  Increase  |  
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This weekend we celebrate mothers. Our moms support us and comfort us. They're loyal and dedicated. And we can rely on and trust in them.

We went looking for stocks that mom would approve of—high-quality stocks that don't cause much trouble, that (like mom) are strong and dependable, and that allow us to rest easy in our investments.

To find stocks to fit the bill, we screened for the following:

Morningstar Economic Moat Ratings of wide: Firms with wide moats have unmatched advantages that should allow them to fend off their competitors and outearn their costs of capital for the next 20 years. By their very natures, wide-moat companies are reliable in terms of their businesses—think of them as "steady-Eddies."

Stable or positive moat trends: To qualify, a company needs to be growing its competitive advantages, not facing impossible-to-overcome headwinds that may ultimately threaten its moat.

Low uncertainty: Such companies enjoy sales predictability, modest operating and financial leverage, and limited exposure to contingent events. As a result of these factors, we can more confidently estimate the future cash flows of these companies—and therefore have high confidence in our fair value estimates.

Exemplary Morningstar Capital Allocation Ratings: Companies that earn the highest marks for stewardship are led by managers who are in shareholders' corners. These managers are exceptional stewards of shareholder capital—and that matters, because capital-allocation decisions ultimately lead to the creation or destruction of value for shareholders.

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Only six stocks made the "mom" cut. But remember: Even reliable companies can be overpriced and therefore vulnerable from a price perspective. Valuation matters. So, while none of the stocks on the list are buys today according to our metrics, they're worth keeping an eye on.

A table showing valuations for Clorox, Coca-Cola, Colgate-Palmolive, Dominion Energy, PepsiCo, and Procter & Gamble

Source: Morningstar Direct; data as of 10 May 2021

Here's a little bit from our analysts about each business.


Clorox (CLX)

"The COVID-19 outbreak has left consumers scouring the shelves for Clorox's fare, leading to a pronounced bump in near-term sales. This has been quite acute in its cleaning mix (about 40 per cent of sales), which soared at a double-digit clip on an underlying basis in each of the past three quarters. We don't think this pace will persist, but we also don't think this sales momentum is limited to cleaning. For one, its grilling segment, which had been plagued by heightened competition and a line-up that failed to pivot toward consumer-valued pellets and lumps prior to the pandemic, seems to be winning from recent social distancing mandates. Although efforts to right the ship were already in place, we think the pandemic is creating an opportunity for the Kingsford brand to re-engage with consumers who are cooking more at home. Even if volumes decelerate as shelter-in-place initiatives are lifted and consumers gradually increase their consumption of food away-from-home, we think Clorox has laid out a solid playbook (inclusive of innovation and marketing to more effectively align with consumer trends) that should steady the grilling business over time. Combined, we continue to forecast 3 per cent annual growth in the health and wellness and household segments (67 per cent of sales) longer term.

"Regardless of the economic backdrop, we don't expect that Clorox will ratchet back brand spend. More specifically, Clorox has long targeted to garner 3 points of annual sales growth from newly launched fare, and we think this focus will continue to contribute to its unwavering competitive position. Further, we are encouraged by management's staunch commitment to funnel additional resources to market its brands, with an aim for advertising to amount to around 11 per cent of sales in fiscal 2021, more than 100 basis points above the prior five-year average. We view this spend as a prudent means to tether its relationships with retail partners and support its brand mix at the shelf. In this vein, we forecast that Clorox will direct north of 12 per cent of sales (about $1.1 billion) on research, development, and marketing each year through fiscal 2030 (about 40 basis points above the level spent between fiscal 2018 and 2020)."

—Erin Lash, director


Coca-Cola (KO)

"Coca-Cola's ubiquity and brand resonance in the nonalcoholic beverage category has been going strong for over 130 years, and we see structural dynamics that will ensure this persists. Despite competing in a mature industry, the firm is adequately exposed, either directly or indirectly, to growth vectors such as premium water and energy drinks. Moreover, we believe Coke will be able to continue extracting incremental value growth from the carbonated soft drink, or CSD, market.

"The runway for growth is supported by ample room for share gains as well as geographic tailwinds. We estimate Coke derives more than 40 per cent of sales from developing or emerging economies with burgeoning middle classes and low per-capita CSD consumption. We expect commercial drinks will become a larger portion of beverage consumption globally, and see the company executing against each of its market-specific strategies.

"In developed markets, where Coke has firmly established the resonance of its brands, its strategies are geared toward profit growth driven by innovation. In developing markets, where its trademarks are visible but competition is rife, differentiation and eventual migration into higher-margin offerings is key. In emerging markets where the firm is less established, it is focused on driving volume growth even at the expense of modest margin dilution. We view these approaches as prudent and believe the decision to cull peripheral brands (going from 400 master brands to 200) will facilitate execution.

"Coke's future trajectory is not without risk, as it faces COVID-19 disruption, secular headwinds in terms of consumer sentiment, and well-capitalized rivals. Still, with a more aligned and technologically capable distribution system, digitization initiatives to drive engagement and operational efficiency, and vast financial resources, the firm is more than equipped to defend its turf. Ultimately, Coke's overarching goal is to put drinks in more hands in more places more quickly than any competitor. We believe this pithy synopsis represents the crux of the firm's competitive positioning, underpinned by its cost advantage and intangible assets."

—Nicholas Johnson, analyst


Colgate-Palmolive (CL)

“While headwinds abounded last year (stemming from the coronavirus and subsequent macro and political angst), Colgate-Palmolive navigated the uncertain landscape quite astutely. With CEO Noel Wallace at the helm, the wide-moat household and personal-care operator's playbook has centered on elevating research, development, and marketing spending (on its core mix, within adjacent categories, and throughout the digital realm) and responding to evolving consumer preferences more expeditiously (bringing products to market in just six to 12 months in some cases, down from 18-36 months historically). The prudence of this course was evidenced as organic sales shot up 7 per cent in fiscal 2020.

"Although a portion of this growth likely manifested from consumers' heightened penchant for personal and home cleaning fare, we don't think oral care has necessarily been a beneficiary of these trends. Rather, we surmise the firm's renewed focus on consumer-valued innovation (even that which comes with a higher price) is also playing a hand. We've been encouraged that management isn't letting these products foster on their own but is cultivating its fare with elevated brand spending. More specifically, this spending was up 15 per cent over the year-ago period to 11.8 per cent of sales, higher than the 10 per cent of sales it has directed to marketing on average annually over the prior five years. We don't expect Colgate to pull back on these efforts as we forecast it will expend around 13 per cent of sales (or more than $2.6 billion) annually on research, development, and marketing over our explicit forecast, which we view as a prudent means to support is competitive prowess (including its entrenched standing with dentists, veterinarians, and dermatologists).

"Further, even if the economic landscape remains challenged and promotional angst intensifies, we believe Colgate's portfolio will prove resilient (following the mid- to high-single-digit quarterly gains during the 2008-09 recession). And we're encouraged that management's rhetoric suggests a commitment to investing in product innovation (at the premium and lower-priced end of its range) to prompt consumers to stay within its brand pillars regardless of the economic climate."

—Erin Lash, director


Dominion Energy (D)

"Dominion Energy changed its name from Dominion Resources in 2017. More importantly for investors, however, the company also made a strategic pivot. Since 2010, Dominion has focused on the development of projects with conservative strategies, exited the exploration and production business, sold or retired no-moat merchant energy plants, and made plans for significant investments in moaty utilities infrastructure.

"Dominion has accelerated its capital expenditures and now expects growth investments supporting net-zero carbon emissions to be roughly $72 billion over the next 15 years, including $17 billion for the largest offshore wind farm in the United States. This should support 6.5 per cent annual earnings per share growth following the earnings decline in 2020 owing to the abandonment of the Atlantic Coast Pipeline and the sale of most of the assets in the gas transmission and storage segment.

"About 90 per cent of earnings will be from regulated electric and gas utilities with constructive state regulation in Virginia, Utah, Ohio, West Virginia, and the Carolinas following the sale of the gas transmission and storage assets. The balance of earnings will come from contracted assets with long-term agreements with mostly investment-grade counterparties.

"Dominion increased its dividend 17 consecutive years before a 33 per cent cut in fourth-quarter 2020. A dividend increase of 0.8 per cent was declared for first-quarter 2021 and represents a payout ratio of approximately 65 per cent of our 2021 earnings estimate. We believe Dominion's dividend yield and earnings growth outlook could deliver high-single-digit returns through this decade and beyond."

—Charles Fishman, analyst


PepsiCo (PEP)

"For many consumers, the Pepsi trademark elicits images of cola containers and curated ads extolling the brand's taste superiority versus Coke. While PepsiCo is still a beverage behemoth, its exploits now extend beyond this industry, with Frito-Lay and Quaker products accounting for over half of sales and over 65 per cent of profits, by our estimate. A diversified portfolio across snacks and beverages is the crux of many of the company's competitive advantages, in our view. Though management missteps have stymied performance in the past, the confluence of better execution and benefits inherent to its integrated business model has allowed Pepsi to reaccelerate profitable growth, and we see plenty of room to run.

"After years of sluggish sales growth and underinvestment, Pepsi has committed to reinvigorating its top line. To that end, significant investments have been made in manufacturing capacity (for example, production lines to meet demand for reformulated packaging), system capacity (route optimization and sales technology), and productivity (harmonization and automation). We view these investments as prudent and believe they will allow the company to strengthen key trademarks such as Mountain Dew and Gatorade, deepen its presence in growth markets like sub-Saharan Africa, while also yielding enough cost savings to reinvest and widen profits. Recent strategic pivots within the energy category (such as the acquisition of Rockstar and Mountain Dew line extensions) should also underpin growth and margins.

"Pepsi's growth trajectory is not without risk, as the company faces secular headwinds such as shifts in consumer behaviour. Additionally, shifting go-to-market dynamics, such as online commerce that encourages real-time price comparisons and obviates the extent of Pepsi's retail distribution advantage, allow for more nimble and aggressive competition. Still, we believe that structural dynamics emanating from Pepsi's scale, the cachet of its brands, and the breadth of its portfolio, which support its wide moat, should enable the company to maintain and augment its competitive positioning."

—Nicholas Johnson, analyst


Procter & Gamble (PG)

"It wasn't long ago that Procter & Gamble was dogged for its lacklustre revenue growth; however, after posting its 11th consecutive quarter of at least mid-single-digit organic revenue growth, these concerns are now a distant memory. We acknowledge that P&G's essential, trusted items are being propped up by the pandemic, given consumers' proclivity for personal and home cleaning and health-related fare. But we think P&G's improving performance would have happened even without the pandemic, thanks to its radical decision more than six years ago to materially prune its brand mix (cutting more than 100, leaving it with just 65) to focus its resources on its highest-return opportunities as a way to more nimbly respond to evolving consumer trends. In this manner, it adopted a more holistic approach to brand investing across its business (consisting of how a product performs, the packaging, brand messaging, execution in stores and online, and the value a product offers for its retail partners and end consumers) that we think should support its wide moat long term.

"But even as its top line appears healthy, P&G now faces unrelenting commodity cost inflation that management qualitatively pegged as some of the most significant in some time. In response, P&G intends to implement mid- to high-single-digit price increases across its US baby, feminine, and adult incontinence segments this fall. We're cognizant that consumers could balk at price hikes by trading down or out of certain categories. However, we think the degree of inflation combined with P&G's innovation mandate (rooted in consumer-valued new fare) should make such increases more palatable. As evidence, pricing has only detracted from the firm's top line once in the past 16 years. Further, we're encouraged that P&G is leaning into brand spending to illustrate the value its products offer consumers as opposed to turning off the spigot to preserve profits in this uncertain climate. This aligns with our forecast for P&G to direct around 3 per cent and 11 per cent of sales long term to research and development and marketing, respectively, up from 2.7 per cent and 10.3 per cent on average the past three years, which we view as prudent."

—Erin Lash, director

is director of content for Morningstar.com.

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