Core Concepts: Consumer Plays

This column was originally published on RealMoney on March 8 at 9:56 a.m. ET. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

In our search for undiscovered value using a methodical sector-by-sector approach, we've taken a look at chemicals, computers and office supplies, oil stocks, telecom, household products, machinery stocks and auto retailers. Today, we'll continue this quest for stock ideas by examining beverage stocks and grocers.

Not Much Fizz

Beverage companies are popular, in part, because they deliver consistent operating performance. Leading companies in this sector include Coca-Cola (KO Quote), PepsiCo (PEP Quote) and Anheuser-Busch (BUD Quote).

While operating consistency is the hallmark of the group, it's the bane of bargain-hunters, who seek to take advantage of the market's tendency to overreact. But when it comes to beverage companies, the market doesn't get a chance to overreact to any perceived chaos because of their remarkable consistency. On the basis of my valuation work, not one of the premier beverage stocks named above has been materially undervalued (by 20% or more) for well over 10 years.

In addition to operational consistency, beverage makers are noteworthy for their amazing efficiency with capital. Coke will generate more than $6 billion in cash earnings this year, while using only $17 billion in equity capital. Anheuser-Busch will generate more than $2 billion in cash earnings this year, using only about $4 billion of equity capital.

Think of return on equity (ROE) as comparable to the rate of return that you generate on your "net assets" -- that is, your total assets minus debt. The fact that the beverage companies can consistently generate 35% to 50% annual returns on their net assets is quite impressive. By way of comparison, premier companies such as Costco (COST Quote) and Target (TGT Quote) generate ROE of 11% and 18%, respectively. My guess is that the average publicly traded company now has an ROE of 10% to 11%.

One beverage stock that I highlighted to RealMoney subscribers in a past column is Molson Coors (TAP Quote). I included the stock as one of my Top 10 Turnarounds for 2006 when it traded at $66. Now at $85, the stock still has decent upside. Margins have been improving steadily since the 2005 merger of Molson and Adolph Coors. There's still plenty of margin leverage to be unlocked. I think the company can earn $6.55 per share in 2009, suggesting a $105 stock value (at 16 times earnings).