Finding stocks to buy is about assessing risks and rewards. Even with businesses that make products people use every day, investors need to be careful.
In my view, there are some good opportunities in the consumer staples sector at the moment. But there are some stocks where I think the equation looks less good for investors.
Risks and rewards
Investing in stocks always comes with risk. Even shares in the safest companies are riskier than other assets such as cash or government bonds.
In my view, though, the point of investing isn’t to avoid risk. Rather, it’s to take calculated risks in cases where the potential reward on offer is worth it.
Imagine a game that involves rolling two dice. You win £500 if the numbers shown add up to anything other than 12, but if they sum to 12, then you lose £1.
This game is risky – you might lose. But it’s also clearly worth playing, because an 11-in-12 chance of winning £500 is worth the risk of a 1-in-12 chance of losing £1.
The way I see it, investing is similar. It involves taking on risk, but only when the potential reward is clearly worth it.
Kraft Heinz
Kraft Heinz (NASDAQ:KHC) is one of the largest stock investments in Warren Buffett’s Berkshire Hathaway portfolio. And I think the shares look like good value at the moment.
The biggest risk with the stock is inflation. The company has some strong brands, but its ability to raise prices to maintain margins without losing customers isn’t unlimited.
Higher input costs are likely to affect all businesses in the packaged food industry, though. And I think Kraft Heinz’s size should allow it to exploit economies of scale that others can’t.
The company has also been improving its balance sheet significantly over the last five years. This should put it in a position to see out a period of short-term pressure on margins.
At a price-to-earnings (P/E) ratio of 12, the shares look reasonably priced. And a 5% dividend yield is enough of a reward for me to conclude the risks are worth it.
British American Tobacco
With British American Tobacco (LSE:BATS), though, I don’t think the 9% dividend is worth the risk. The problem is that proportion of smokers around the world is in decline.
In certain regions, like Africa, the Western Pacific, and the Eastern Mediterranean, this is offset by a high birth rate. The number of smokers in these areas is thus set to rise by 2025.
Unfortunately, most of the company’s sales come from elsewhere. Over 66% of British American Tobacco’s revenues come from Europe and the US.
Both of these geographies have low birth rates (Europe 1.49, US 1.65), meaning the number of smokers in these areas is falling. This looks like a big problem to me.
As a result, I think the stock looks extremely risky. The dividend yield might be high in the short term, but I don’t believe this is enough to offset the long-term threat to the business.
