Peer Pressure Cools Consumer StocksAll this internal progress isn't going to do the trick, however. Research that I find pretty convincing argues that over the short term (by that, I mean six months to a year), a stock's industry or peer group accounts for most of its momentum. True, the stocks of well-run companies can fight against the currents moving the group. If management is really good, the stock may decline less than its peers. But decline it will. There's very little profit to be made, within this time horizon, from fighting the trend of the group. And for the next year, I see the tides of the economy and the financial markets running strongly against this group of stocks. (For more on this idea, see "Do Industries Explain Momentum?" by Tobias Moskowitz and Mark Grinblatt in the August 1999 Journal of Finance.) I think three things are running against Coca-Cola and friends.
- Inflation is just not high enough to let consumer companies raise prices easily. It's easy to overlook how important modest inflation is as a cover for price increases. A price jump of 2% or so above the rate of inflation is pretty much invisible to consumers. If prices in general are going up 5% or 6% a year, a company easily can get away with increasing its prices by 7% or 8%. Who notices? But when inflation is low, companies that try such aggressive price increases are likely to see unit sales decline. They may even face a rebellion by consumers or middlemen. Coca-Cola bottlers balked when the company raised prices for its syrup concentrate, for example. The bottlers feared that they wouldn't be able to pass the cost along to consumers and would wind up eating the increase themselves. Right now, the Federal Reserve seems determined to raise interest rates to slow the growth of the economy. And mature consumer-goods companies find it difficult to increase unit sales faster than the growth of the general economy. Grabbing a significant increase in market share is extremely expensive -- if it's even possible. Increasing productivity and cutting costs is relatively difficult for mature consumer-goods companies as well. It's not like Coca-Cola is about to find some breakthrough technology for producing soda, after all. Add in difficulties in raising prices in a low inflation environment and it's easy to see why these companies have produced only single-digit increases in revenue and income in recent quarters. These trends, and events like the 1998 crisis in Asia that sent demand for consumer products into a regional decline, have seriously eroded the financial rationale for owning these stocks. Sure, these stocks weren't expected to grow at the rates of an Oracle ( ORCL) or a Texas Instruments ( TXN), but they had dependably produced double-digit growth. The boring predictability of that growth had justified a price-to-earnings ratio of 50 to 70 for a stock where earnings were growing by 15% to 18% a year. But that changed. First, investors discovered management couldn't deliver the traditional numbers. Then they were surprised again when management, after much pain, produced lower targets and still missed them. With earnings growth of these companies seemingly no longer so predictable, investors lost a major reason to own the group. And that's a problem, given that many of these stocks still trade at almost twice the multiple of the S&P 500. (Coca-Cola's P/E ratio, for example, is still 58 as I write this.)
- A tad more inflation would help. These companies need to regain some pricing power. An end to worries that the economy is going to slow. That will take a clear declaration from the Fed that it's done raising rates for a while. A return to predictable growth, even at a lower level, for a long enough period of time to persuade investors to trade some of their volatile technology stocks for safer shares.