Part of the appeal of the consumer ETFs is that they are anchored by companies with long records of producing high returns on equity. Big holdings with rich profits include Kimberly-Clark (KMB), maker of Kleenex tissues, and cereal maker General Mills (GIS). According to academic research, businesses that generated fat profits in the past tend to thrive in the future. In a recent study, Chuck Joyce and Kimball Mayer, portfolio managers for GMO, looked at the profitability of the 1000 biggest stocks five years ago. Then they checked to see if the performance persisted. The researchers found that profitable companies tend to stay that way.
The GMO managers say that companies can only achieve persistent high profits if they have big advantages, such as superior brands, strong franchises, or intellectual capital that competitors cannot easily duplicate. Companies that gain advantages tend to keep them for years. The researchers cite the example of Tootsie Roll (TR) and lubricant maker WD-40 (WDFC). "Each of these companies has huge brand recognition and the profitability to match," Joyce and Mayer wrote in a recent white paper.
The profitable companies rewarded investors with superior returns, the GMO researchers found. This occurred because the reliable performers tended to be undervalued and overlooked by investors who had little interest in boring companies. "Their predictably higher profits are not quite high enough to command the attention of a market in thrall to the possibility of the next big jackpot," the researchers wrote.The GMO research should reassure investors that the consumer ETFs can make solid holdings. Just as consumer staples delivered steady returns in the past, they should remain reliable holdings going forward.