Most consumers can live without the latest iPod from Apple (Nasdaq: AAPL) or a brand new 46-inch high-definition television. Such products are known as discretionary purchases -- consumers will decide to buy or not buy these products based on a variety of factors including income, expectations for future income growth, and willingness to take on debt.

But while you might think twice before shelling out $2,500 on a new television, it's unlikely you gave much thought to your last purchase of a $1.00 pack of chewing gum, $0.50 soda, or $7.00 tub of laundry detergent. In fact, if you're like most consumers, then you'll continue chewing gum and doing your laundry regardless of the general condition of the U.S. economy.

Companies that make or sell these everyday necessities are called "consumer staples" firms. Typically, the consumer staples industry includes traditional food and beverage companies as well as grocery retailers, fast-food chains, and drugstores. Companies in these industries are exposed to different competitive forces; they're by no means fundamentally identical. However, all of these industries share one common trait -- stable demand for their products.

That stability of demand is behind the consumer staples industry's reputation as a safe group. And there's a great deal of truth to the sector's reputation for stability; during bear markets and periods of poor economic growth, consumer staples tend to handily outperform most other industry groups. 

The most recent bear market in stocks lasted from mid-March of 2000 through early October of 2002. As the chart shows, the S&P 500 Consumer Staples Sector handily outperformed the broader S&P 500 Index over this period.

Of course, while demand for basic products tends to be stable and recession-proof, these products don't typically see rapid growth in demand. In the U.S., for example, demand for food and beverages grows at around 1-3% annually. 

But don't be tempted to simply generalize consumer staples as a slow-growing, defensive group to hide in when the market is going down. While there are certainly companies that fit the bill, there are also a handful of standouts with a track record of growing faster than their industry, developing innovative high-growth products, and expanding into new markets.

And don't assume steady growth means boring returns for investors. Consider the case of British alcoholic beverages maker Diageo (NYSE: DEO). While most investors were licking their wounds during the 2000 to 2002 bear market, Diageo returned more than +70%. Even more amazing, the stock has continued to outperform since the 2002 market low -- Diageo is up more than +95% since October 2002 compared to just +57% for the S&P 500.

To differentiate the top performing consumer staples stocks from the also-rans, here are three of the most important factors to consider:

Branding/Pricing Power
Just think about your last trip to a grocery store -- you probably noticed several different types of colas, including both well-known brands like Coca-Cola (NYSE: KO) and generic brands produced by supermarket chains or other private label distributors. Even though the generic brands are significantly cheaper than the branded names, most consumers still buy Coke and Pepsi (NYSE: PEP) and are more than willing to pay the premium price.

That, in a nutshell, demonstrates the power of branding. Consumers are intensely loyal to their favorite brands and the best brands have the power to raise prices and earn superior profit margins even in weak economic times. Just about anyone can make cola, chewing gum, or even gin. But there is only one Coke, Wrigley's, and Tanqueray -- while many consumer staples are basically homogenous products, it's the brand that confers the competitive advantage.

And strong brands also confer other advantages than simply superior pricing power. For example, companies can leverage an existing brand to introduce new products -- Vanilla Coke, Tanqueray No. Ten gin and Microwavable Bounty towels are all examples of successful brand extensions that gave new products instant name recognition.

International Growth
While growth in demand for many basic consumer staples is slow in mature economies, developing markets are a different story. Consider, for example, that the average American chews about 180 sticks of gum annually. Meanwhile, the average Chinese consumer enjoys only 15-20 sticks. Similar patterns are evident in all sorts of consumer staples products, from alcohol to detergent to Taco Bell (NYSE: YUM) burritos.

As developing economies become wealthier, consumption of basic staples accelerates rapidly. Eventually, consumption of these basic products is likely to approach the same levels as in the developed world. This implies growth rates in the developing world that are far larger than in the U.S. or Europe. Companies with the scale and scope to expand into rapidly developing emerging markets will see strong growth for years to come.

Raw Materials Costs
Raw materials costs have been a key factor for some consumer staples products firms recently. For example, cereal is made from corn, and corn prices have skyrocketed lately. The same is true of wheat and other basic bulk commodities. That raises the cost of making cereal. If producers can't raise prices enough to cover rising costs, then profit margins get squeezed.

To keep on top of these trends, keep an eye on a company's operating profit margins -- operating income divided by total sales. If operating profit margins start shrinking, then this can be a sign of rising costs eating into profitability.

With these points in mind, we'll take a closer look at two consumer staples firms that enjoy recession-resistant demand for their products and have the potential for superior growth.

Additional Industry Profiles . . .

Alcoholic Beverages Alternative Energy Bulk Shipping Casinos Coffee Retailers Consumer Staples Credit Cards Credit Ratings Debt Collection Deep Discounters Ethanol For-Profit Education Gold and Silver Grocery Retailers Healthcare Supplies & Services Natural Gas Online Travel Outdoor Advertising Railroads Satellite Radio Slot Machines Title Insurance Wineries

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