As the Premier League kicks off a new season, here on The Value Perspective we cannot help but dwell on the staggering amounts of money being spent on new players – almost £900m in total, with more than two weeks still to go before the summer transfer window closes – and the not unrelated question of how many of the deals done have even a nodding acquaintance with the concept of value.
Boosted by the almost £90m Manchester United have splurged on Paul Pogba, Premiership clubs have spent an average of £10.3m per transfer this summer – a more than 50% rise on last season’s average of £6.4m. Among the headline deals then was United’s £36m signing of Anthony Martial, which allowed us to suggest, in Martial Lore, that the idea of ‘paying for hope’ is not confined to the world of football.
To help make our point today, however, we will go back in time a lot further than 12 months – to a deal done two decades ago. In November 1996, a Senegalese striker called Ali Dia secured a one-month contract with Southampton – apparently largely because he persuaded the then-manager Graham Souness he was the cousin of the FIFA World Player of the Year George Weah.
As it happens, Dia did not even manage one game as, brought on as a substitute after 32 minutes, he was substituted in the 85th minute after running around, as Saints legend Matt Le Tissier put it, “like Bambi on ice”. Regularly hailed as one of the worst football deals of all time, the episode is also a great example of how you can pay up for one thing and end up with something wholly unexpected instead.
From there, it takes but a tiny fraction of Dia’s Premier League career for us to wonder whether the lesson handed out to Souness and Southampton two decades back is now on the cards for anyone invested in consumer staples stocks, such as food and beverage businesses, household goods companies and the tobacco sector.
Not so long ago, as we have noted in articles such as Lost and pounds, huge litigation threats and not unreasonable concern about a business model that involved killing off all their customers left tobacco stocks almost friendless. But times change, qualities such as pricing power gained the sector many new friends and standard-bearer British American Tobacco is now the third largest stock in the FTSE 100.
What is more, consumer staples companies now make up the same proportion of the FTSE 350 as both the resources – that is, all mining and oil-related businesses – and financial sectors put together. Switch to the MSCI Europe benchmark – for reasons that will soon become apparent – and a similar picture emerges, with consumer staples accounting for 17% of that index.
These stocks have, in short, had a fantastic run – a point only further underlined by MSCI’s practice of slicing and dicing its indices into investment styles, such as value, quality and momentum. Looked at in this way, consumer stocks make up 30% of the MSCI Europe’s momentum index and just 3% of its value index.
When people buy consumer staples, it is traditionally for their steady growth prospects and the comfort this can offer regardless of the economic environment. When, however, people buy them because they are going up in price and with no regard for valuation, as those respective weightings in the momentum and value indices now suggest, then tradition, steadiness and comfort have largely left the building.
As we argued in The hunt for oats and income, investors’ thinking appears to be being muddled by ultra-low interest rates and now it is almost as if they have convinced themselves they can buy consumer staples stocks no matter their cost. But they cannot – and the reality is many are buying these stocks not for their underlying quality but for the simple reason they are going up in price.
In essence, they are not buying what they think they are buying – high-quality businesses with stable earnings – but very sensitive and increasingly expensive assets. On that latter point, consumer staples are reaching a point where the ‘contrast effect’ kicks in – that is, when the alternative is low or even negative bond rates, investors may cease to care whether they are paying, say, 24x or 25x earnings.
Here on The Value Perspective, of course, what an asset’s current price implies about future returns is a constant concern. Consumer staples may be wonderful businesses but, when investors have become so insensitive to valuation they are buying them at current levels, things need to go very right for a very long period of time if they are not going to end up as the portfolio equivalent of Ali Dia.