Why FMCG stocks are considered as defensives in equity markets?

If you are aware with the fact that FMCG stocks are considered as safest bets to invest when equity markets get deviated from the arithmetic mean, chances are investment in stock market is your cup of tea. No matter how much aggressive or defensive investor you are whether you invest in largecap, midcap or smallcap and who’s investing philosophy your follow, you will turn to FMCGs when markets get topsy-turvy. Fast-moving consumer goods are those products that cater the recurring needs of the people and are relatively lower in price such as cosmetics, white goods, soft-drinks, and other goods which have short shelf life. FMCG is the only sector which reaches every possible tier cities in a country. The companies that undertake the operations associated with FMCGs production have lower growth rate, intensive distribution method and high volumes. Despite the lower growth rate in the volumes, the FMCG companies enjoy a decent premium in valuations and first choice for investors to buy when bears get settled on the driving seat.

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Reasons that derive high valuations and less standard deviation to FMCGs:

  1. Short-lived Cash Conversion Cycle: Cash conversion cycle in any business is considered as a significant parameter to value their fundamentals. A quick conversion cycle restricts them from heavy investment as they do not raise funds heavily in order to cater their fixed and working capital requirement. Moreover, the cost of capital on which they acquire funds is less in comparison with other type of industries due to their higher ability to augment interest obligations and low exposure to bankruptcy.
  2. Debt-free status: The acquisition channel of funds for augmenting the working capital requirements or investment for expansion in business has always been controversial as fund raising from debt market slices the earning per share but raise concerns for equity shareholders due to more exposure. There is no denying the fact that inculcation of debt component into capital mix brings tax benefits on interest obligations. While, history has seen favoring companies which are debt-free due to no cost in times of recession/depression Majority of the FMCG stocks have no availability of debt component in their capital structure that put investors in a comfortable position.
  3. High Dividend Yield: It is worth-mentioning that FMCG companies don’t make much investment despite having stellar free cash flows and revenues from main operations as they have less room for expansion. So, they bank upon more distribution of earning per share rather than the advancing their retention ratio. High dividend-distribution stocks help investors to hide behind safer returns in turbulent times. This is the reason why investors sprint for FMCG stocks while meltdown.
  4. High Entry Barriers: FMCG is the only sector where entry for any business corporate is easy due to no licensing fees and research associated capital outlay but higher cost on branding, advertising, patent rights and expansion of product line restricts other corporate to enter in FMCG mammoth. Therefore, the oligopoly structure followed in the FMCG sector kept the revenues withhold.
  5. Constant Demand in every business cycle: Each and every business goes through slippage in sales in times when economy walks through turbulent times. In times, when economy walk a boom phase, real estate market rockets high, automobile sales shoot up, steel production touches sky and loan distribution from banks and NBFCs touch ceilings while in recession and depression cycle, production and sales numbers get deteriorated. FMCG is the only industry whose sales are affected much less in aggressive periods of business cycle, which keeps its revenues and growth rate constant.

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