Market Overview

Paying Up To Play Defense With Staples ETFs

Paying Up To Play Defense With Staples ETFs
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Defensive sectors, such as consumer staples, have their advantages, namely solid dividend yields and a lack of volatility. However, that does not mean exchange-traded funds such as the popular Consumer Staples Select Sect. SPDR (ETF) (NYSE: XLP) are free lunches.

Rather, the opposite is true, as playing defense with low volatility sectors usually subjects investors to rich multiples. Investors have been willing to do that this year, as defensive and low volatility have become prized traits, helping XLP to a year-to-date gain of 2.4 percent and inflows of $1.27 billion, good for one of the best totals among all sector ETFs.

Still, XLP is expensive. At least according to AltaVista Research, which estimates the ETF will trade at 20.8 times earnings this year, well above the research firm's 16.2 price-to-earnings ratio estimate for the S&P 500. Only two of the 11 sector SPDR ETFs are expected to be pricier this year than XLP, according to AltaVista.

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As such, the research firm rates XLP Underweight, a rating AltaVista assigns to richly valued sectors or those groups that display poor fundamentals. Chances are it is not staples' fundamentals that have garnered XLP that lackluster rating.

Digging Deeper Into XLP

XLP also sports a better-than-Treasurys 2.54 percent dividend yield and the ETF is home to several dividend aristocrats. However, vulnerability to a stronger dollar cannot be ignored.

Marquee names in the ETF include Dow components Procter & Gamble Co (NYSE: PG), The Coca-Cola Co (NYSE: KO) and Wal-Mart Stores, Inc. (NYSE: WMT), the world's largest retailer.

“Earnings declined slightly last year as margins got squeezed, in part by the strong USD. Estimates for this year and next look better although the top line seems a bit aggressive to us. In any case Consumer Staples stocks have seen their valuation multiples expand considerably over the last five years and as a result these stocks appear rather expensive, leading to an Underweight recommendation,” said AltaVista.

Food and beverage makers and retailers combine for about 62 percent of XLP's weight while household products manufacturers account for nearly 20 percent of XLP. Tobacco stocks are 16.4 percent of XLP's lineup.

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