The consumer staples sector is characterized by its global industry classification sector (GICS). The sector is composed of companies whose primary lines of business are food, beverages, tobacco and other household items. Examples of these companies, include Procter & Gamble (NYSE:PG), Colgate Palmolive (NYSE:CL) and Gillette. These types of companies have historically been characterized as noncyclical in nature as compared to their close relative, the consumer cyclicals sector.

Unlike other areas of the economy, even during economically slow times (in theory), the demand for the products made by consumer staples companies does not slow. Some staples, like discount foods, liquor and tobacco, see increased demand during slow economic times. In line with the noncyclical nature of the demand for their products, the demand for these stocks tends to move in similar patterns. Read on to find out why the staples sector has historically had a low correlation to the overall market, and why this sector has historically experienced lower volatility. (For related reading, see Cyclical Versus Non-Cyclical Stocks.)

Staples and Supply and Demand
Anyone who has taken a basic economics class remembers the function C+I+G = GDP, where gross domestic product (GDP) is the aggregate of consumption, investment (often referred to as business spending) and government expenditures. So, if consumption comprises such a large component of GDP, why is the sector weighting of consumer staples in the U.S. stock market only around 10% or less historically? The best explanation of this relationship is the noncyclical nature of the demand and earnings of those companies.

Staples tend to have a low price elasticity of demand. This means that the demand for these products does not change much as their prices go up or down. There are no substitutes for the products themselves; however, there are many options to shop for lower prices among suppliers. This gives the suppliers of staples little room to raise prices or increase demand for their products. Suppliers do, however, have the ability to differentiate their products by the taste, appearance or results of using their products. This leaves the producers of staples in the cross hairs of the main costs that go into making their products: commodities. (Find out how the everyday items you use can affect your investments in Commodities That Move The Markets.)

If the demand for consumer staples does not grow by much, how do the producers or sellers of staples grow their businesses and ultimately their stock prices? They have a few options:

  1. Reduce costs
  2. Reduce prices
  3. Differentiate their products.

Cost Reduction
Companies in the business of consumer staples can grow their profits and ultimately their stock prices by reducing costs. They can reduce their commodities costs by buying larger quantities, using hedging techniques, merging with or buying other companies, and creating economies of scale via horizontal integration or vertical integration.

Price Reduction
We have already described the demand of staples as being low in elasticity. We also know that with competition, the same box of pasta at a high-end retailer will sell for more than at a low-end retailer. This price differentiation will be much more apparent during slower economic times when the consumer steers toward the low-end retailer.

Product Differentiation
This strategy to increase demand is used by the staple and cyclical ends of the consumer business. From cars to razors, each consumer product company tries to differentiate its product as superior in order to increase demand and give the company the ability to control the item's price.

Opportunities for Investors
The business of consumer staples is relatively low tech, composed of commodities that vary in cost, tends to be low in elasticity and shows fewer swings in demand than the cyclicals. So if this business is so boring, why would anyone want to invest in consumer staples?

One of the best reasons is slow and steady growth. Since the ebb and flow of the consumer spending cycles swings wildly with the economy, so do the profits of the cyclical companies. The staples, on the other hand, tend to move in more structured patterns - boring, maybe, but for some investors, this relative stability is just right.

Another reason for committing capital to the staples sector is the diversification benefits of owning those companies. While the sector itself may make up less than 10% of the overall market historically, the correlation between the sector and the overall market is low. (Learn how to diversify your portfolio by investing in several different sectors of the economy in An Introduction To Sector Funds and Singling Out Sector ETFs.)

The staples sector has historically exhibited a beta of .68 and a correlation of .64. Herein lies the best-kept secret of owning consumer staples: a low correlation to the Standard & Poor's 500 Index (S&P 500). It is pounded into the heads of investors to diversify their stock portfolios with holdings whose asset classes have low correlations, so they add bonds, international stocks, oil, real estate and gold. While this has worked historically, there have been times when all of those asset classes had higher correlations as they all fell and the staples sector maintained its value. This is just one of those backup singers of the market that does not get much attention until it's too late.

It's safe to say that the business of consumer staples and investing in them is boring to some people. The demand for these products does not swing up and down and they don't exhibit the flashy characteristics of their close relative, the consumer cyclical.

They do, however, offer investors an opportunity to diversify into a sector that is easy to understand, has a relatively low beta and a low correlation to the overall market. So the next time you go to buy a razor when the stock market is in a tailspin, take a look at the company that makes that razor: it might be a good time to buy its stock.

Related Articles
  1. Retirement

    How Are 401(k) Withdrawals Taxed for Nonresidents?

    As a U.S. nonresident, deciding what to do with your 401(k) after you return home comes down to which tax penalties, if any, you're willing to incur.
  2. Economics

    These Will Be the World's Top Economies in 2020

    Discover the current economic forces that are anticipated to significantly shift the landscape of the world's most powerful economies over the next decade.
  3. Mutual Funds & ETFs

    Top 3 Japanese Bond ETFs

    Learn about the top three exchange-traded funds (ETFs) that invest in sovereign and corporate bonds issued by developed countries, including Japan.
  4. Taxes

    Here's How to Deduct Your Stock Losses From Your Tax Bill

    Learn the proper procedure for deducting stock investing losses, and get some tips on how to strategically take losses to lower your income tax bill.
  5. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  6. Savings

    Become Your Own Financial Advisor

    If you have some financial know-how, you don’t have to hire someone to advise you on investments. This tutorial will help you set goals – and get started.
  7. Investing Basics

    6 Reasons Hedge Funds Underperform

    Understand the hedge fund industry and why it has grown exponentially since 1995. Learn about the top six reasons why the industry underperforms.
  8. Stock Analysis

    3 Solar Stocks to Add to Your Portfolio

    Understand the growth and challenges of the renewable energy market and its success in 2015. Learn about the top three energy stocks to add to a portfolio.
  9. Investing Basics

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  10. Economics

    Calculating Cross Elasticity of Demand

    Cross elasticity of demand measures the quantity demanded of one good in response to a change in price of another.
  1. What are the main kinds of annuities?

    There are two broad categories of annuity: fixed and variable. These categories refer to the manner in which the investment ... Read Full Answer >>
  2. What are the risks of rolling my 401(k) into an annuity?

    Though the appeal of having guaranteed income after retirement is undeniable, there are actually a number of risks to consider ... Read Full Answer >>
  3. How do I get out of my annuity and transfer to a new one?

    If you decide your current annuity is not for you, there is nothing stopping you from transferring your investment to a new ... Read Full Answer >>
  4. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  5. Is Colombia an emerging market economy?

    Colombia meets the criteria of an emerging market economy. The South American country has a much lower gross domestic product, ... Read Full Answer >>
  6. Can my 401(k) be seized or garnished?

    As long as your retirement funds are held in your 401(k) and you do not take them as distributions, your 401(k) cannot be ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  2. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  3. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  4. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  5. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  6. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!