What Consumers Want: Part 3

Translating Consumption to Returns

What Consumers Want: Part 3

In the previous installments of our What Consumers Want series, Infusive Intelligence closely analyzed consumer consumption from both a micro and macro view. Yet consumption is only part of the Consumer Alpha™ philosophy. Equally important is identifying how consumer purchases impact a company’s long-term financial performance and, ultimately, returns to investors.

To understand the “why” behind Consumer Alpha™, we study and analyze the equity returns of the industries that make up the Consumer Alpha™ universe. As long-term investors, we ultimately care about how consumption translates to investment performance. To best predict the future, we must first understand how different consumer goods industries have performed historically, through varying economic cycles and in comparison to non-consumer goods industries.

To build a framework for our analysis, we relied on industry portfolios constructed by well-respected investment researchers Eugene Fama and Kenneth French. Fama and French compiled every stock in the NYSE, AMEX and NASDAQ indices and grouped them into industry categories of increasing detail, resulting in 49 discreet industry portfolios. For our analysis, we further segmented the Fama and French portfolios into a group of six portfolios that contain the most tangible Consumer Alpha™ characteristics.

Exhibit One

Source: Fama and French

Source: Fama and French

These portfolios, identified in Exhibit One, include Candy and Soda (candy and other confectionary, bottled and canned soft drinks and potato chips); Beer and Liquor (beverages, malt beverages, wine and distilled liquor); Tobacco Products, Entertainment (motion picture production and distribution, motion picture theaters, amusement and recreation, and professional sports); Consumer Goods (perfumes, cosmetics, luggage, and jewelry); and Apparel.


So what has performance been over different timeframes for these portfolios? To find out, we utilized two well-known risk-adjusted performance metrics – the Sharpe Ratio and the Sortino Ratio.


Source: Fama and French, Infusive Intelligence

Sharpe Ratio

This ratio computes risk-adjusted returns by taking the portfolio’s excess returns over the risk-free rate for a given timeframe and divides the excess return’s standard deviation over the same timeframe.

Sortino Ratio

This ratio is a modified version of the Sharpe Ratio. While the Sharpe Ratio penalizes upside volatility and downside volatility in its denominator, the Sortino Ratio only does so for downside volatility.

We then applied both the Sharpe and Sortino Ratios over three different timeframes – 1960 through 2014 (54 years), 1985 through 2014 (29 years) and 2004 through 2014 (10 years).

Exhibit Two identifies the performance of 46 Fama and French portfolios across the three different timeframes and against both ratios. Initial rankings are by the Sharpe Ratio in the 1960-2014 timeframe.

Every one of the six Consumer Alpha™ portfolios (noted in orange text) scored within the top 20 in the longest timeframe – 1960 through 2014 – for each ratio. When the timeframe was narrowed to 1985-2014, three of the portfolios – Beer and Liquor, Tobacco Products, and Consumer Goods – made the top ten. Restricting the timeframe even further (2004-2014) saw Tobacco Products, Apparel, and Candy and Soda make the top ten.


Source: Fama and French, Infusive Intelligence

Source: Fama and French, Infusive Intelligence

To gain a better sense of the drivers behind these findings, it is also important to look at the individual components of the Sharpe Ratio – growth and volatility. We plotted both the compound annual growth rate (CAGR) and annual standard deviation of all the portfolios over the same three timeframes. Exhibit Three identifies the results of this further analysis.

Four of the Consumer Alpha™ portfolios – Tobacco Products, Candy and Soda, Beer and Liquor, and Entertainment – round out the top seven growth portfolios over the 1960-2014 period. In the 1985-2014 timeframe, Entertainment drops out, and in the 2004-2014 period, only Tobacco Products remains and is joined by newcomer Apparel.

Standard Deviation

When it comes to volatility, two Consumer Alpha™ portfolios stand out as consistently scoring in the five least volatile portfolios over all timeframes – Consumer Goods and Beer and Liquor. The remaining Consumer Alpha™–related portfolios have less noteworthy performance in terms of annual standard deviation, particularly Entertainment.


It is important to also understand how different economic environments affect returns. To do this, we rearranged the entire 1960-2014 timeframe into High/Medium/Low growth categories based on growth rates. We then re-calculated our risk-adjusted return metrics (Sharpe and Sortino Ratios) for a subset of 38 Fama and French portfolios, including select Consumer Alpha™ portfolios.

Exhibit Four

Source: Fama and French, Infusive Intelligence

Exhibit Four contains the Sharpe and Sortino Ratios for this subset, with our Consumer Alpha™ portfolios noted in orange text. The Sharpe Ratio initially ranks the portfolios in the Low Growth period.

Of the most importance to us as long-term investors is how these industry portfolios stack up in the different economic environments. To accurately gauge performance, we assigned a value of 0 (zero) to portfolios that scored in the bottom third percentile for a given economic environment. Portfolios that scored in the middle third percentile received a value of 1, and portfolios in the top third received a 2.

Exhibit Five

Source: Fama and French, Infusive Intelligence

Source: Fama and French, Infusive Intelligence

The results of this ranking are demonstrated in Exhibit Five. You can see that, on the whole, Consumer Alpha™-related portfolios tend to perform better in lower growth environments. Three specific portfolios – Tobacco Products, Beer and Liquor, and Entertainment – score in the top third percentile in low-growth environments. When high-growth is present, Tobacco Products and Entertainment fall to the bottom third percentile.

Exhibit Six

But how do our Consumer Alpha™ portfolios compare to the other consumer and non-consumer portfolios? To find out, we averaged the return ratios for all portfolios in each category over each growth regime. Those results are shown in Exhibit Six. One notable discovery, which is consistent with the individual Consumer Alpha™ portfolio results previously noted, is that while the three groups tend to share similar performance characteristics in times of medium- and high-growth, only the Consumer Alpha™ portfolio demonstrates superior performance in low-growth phases.


Beyond testing the relationship between industry portfolio returns and the overall economic cycle, we can also do so with respect to each portfolio’s consumption spending data. To do this, we look to select consumption categories from the Bureau of Economic Analysis. While the Fama and French portfolios may contain differences in consumption categories from those in the BEA data, the categories are similar enough to draw legitimate and insightful conclusions. Exhibit Seven on the following page shows the results of this comparison.

Plotting the real consumption growth rates of the BEA categories over the three timeframes (1960-2014; 1985-2014; and 2004-2014) versus the associated industry returns growth rates show little, if any, relationship between the two. This suggests that while growth may drive some part of returns, other elements such as high returns on capital may have more influence. This appears to be particularly true for Tobacco Products.

Exhibit Seven

Source: Fama and French, Infusive Intelligence

Source: Fama and French, Infusive Intelligence

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