Investing in what we buy's best for all weather and all cycles

The need to invest for the long term is easy to acknowledge but often investors, especially new ones, may feel overwhelmed by a vast number of publicly listed companies to choose from. A simple method, to begin with, is to pay attention to the products, services, and brands that we consume or know well and to work our way up to understand the strength of the business models employed by the respective companies and other factors such as the extent of profitability, future growth potential, and corporate governance. The strategy has been endorsed in the past by noted investors including Warren Buffett.

The approach involves not only consuming products day-to-day but also investing in their parent companies. Some of the well-established companies that are recognised by their products include Colgate (toothpaste), Nestle (coffee, noodles), Britannia Industries (biscuits) and Hindustan Unilever (soaps, shampoos). A prominent reason for the strategy to work is that the majority of the companies in this category belong to the non-cyclical group where demand is usually less dependent on the economic cycles.

Historical data show that non-cyclical companies not only boast sizeable outperformance but also offer higher return per unit risk. Sectors such as fast-moving consumer goods (FMCG), consumer durables, consumer services, telecommunications and textiles are considered non-cyclical businesses. In the past 10 years, the Nifty Non-cyclical Consumer Index has delivered a 17.4% return annually compared with the 14.8% return from the broader market Nifty 500 index.

These companies show lower stock market volatility or beta than cyclical businesses such as cement, construction, and aviation. The standard deviation, a measure of volatility, of stock returns of non-cyclical companies is nearly 2% lower than that for cyclical companies. This means the return per risk of non-cyclical companies is at 0.71 over 10 years compared with 0.57 for the broader index.

With improving geographic reach and the rising propensity to spend, non-cyclical companies are expected to sustain growth in the future. For instance, India’s personal car segment in India, which is close to $15 billion in size, is expected to grow by 10% annually.

Consumer companies have launched low-unit packs (LUPs) to boost sales of premium products in rural and low-income areas. These companies derive 55% of their revenue from urban markets and the remaining from rural ones.

The non-cyclical businesses also score well on corporate governance, balance sheet, return ratios and free cash flows. These companies often have more cash than debt on their balance sheets.

As economies globally deal with rising uncertainty in terms of recession, high inflation and geopolitical crises, markets are likely to be volatile. In this context, non-cyclical businesses are expected to provide much-needed stability to investment portfolios.