We recommend that most investors include top consumer stocks in their portfolios. These can help provide protection against economic downturns—and cut your overall risk.

One of the five main economic sectors for investing is the Consumer sector. Companies like Proctor & Gamble, Kraft Heinz and the spice company McCormick and Co. are all in the Consumer sector. Most top consumer stocks benefit from continuous, habitual use and have a steady core of sales, regardless of the economy and business cycles. These companies typically make products like soap or soup.

Top consumer stocks can help provide protection against economic downturns. That’s a key difference between Consumer stocks and companies in the Manufacturing & Industry or Resource sectors, which are far more sensitive to the ups and downs of the economic cycle.

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The qualities of top consumer stocks

Consumer-sector stocks are apt to fall in the middle, between the more volatile resources and manufacturing companies and the more stable finance and utilities companies.

At the Successful Investor, we like high-quality blue chip consumer-product companies because they can provide stability during a recession or economic slowdown.

Strong consumer product companies share a number of characteristics. These include geographic diversity to protect them from regional economic difficulties, a record of rising cash flow and strong balance sheets. All these are characteristics of blue chip stocks.

The spike in commodity prices which pushed up inputs like transportation and packaging in the early part of this decade pushed many consumer-product companies to deeply cut their costs elsewhere. This has ended up letting them boost their profits as well as free up cash for expanding and upgrading their operations or for increasing their dividends.

We believe that a record of increasing dividend payments is a good indication of a strong company, especially in a slow economy. High-quality blue chip stocks will usually be in a position to remain profitable during almost any type of economic hardship or recession. Plus, you get paid dividends and earn income while you hold these stocks, even if share prices are falling.

How to pick top consumer stocks that pay dividends

The best Successful Investor dividend stocks provide a consistent dividend yield year after year. That’s key to your long-term investment success, because those dividends can contribute as much as a third of your total return.

Good dividend stocks are a valuable component of any sound Successful Investor portfolio. And dividends can grow. Stock prices rise and fall. Interest on bonds or GICs holds steady, at best. But the best dividend stocks like to ratchet their dividends upward over time—holding them steady in a bad year, and raising them in a good one. That also gives you a hedge against inflation.

For a true measure of stability, focus on companies that have maintained or raised their dividends during economic and stock market downturns. These firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they provide an attractive mix of safety, income and growth.

Factors to consider while searching for top consumer stocks

Below is a list of factors we like to see in companies when we look for overall investment quality.

Safety factors:

• Freedom to serve (all) shareholders. High-quality stock picks must be free of excess regulation, free of dependence on a single customer, and free from self-dealing insiders or parent companies.
• Industry prominence if not dominance. Major companies can influence legislation, industry trends and other business factors to suit themselves.
• Geographical diversification. Canada-wide is good, multinational better. There’s extra risk in firms confined to one geographical area.

Financial factors:

• Manageable debt. When bad times hit, debt-heavy companies often go broke first.
• 5 to 10 year history of profit. Companies that make money regularly are safer than chronic or even occasional money losers.
• 5 to 10 years of dividends. Companies can fake earnings, but dividends are cash outlays. If you only buy dividend-paying value stock picks, you’ll avoid most frauds.

Survival/growth factors:

• Ability to profit from secular trends: These trends outlast ordinary business booms and busts, because they reflect ongoing social change. An expanding middle class and rising environmentalism are just two examples of secular trends.
• Freedom from business cycles. Demand periodically dries up in “cyclical” businesses, such as resources and manufacturing. That’s why you need to diversify. Invest in utility, finance and consumer stocks, along with cyclical resource firms and manufacturers.
• Ownership of strong brand names and an impeccable reputation. Customers keep coming back to these businesses, and will try their new products.

Consumer stocks can sometimes fall flat, depending on trends in other parts of the market. What keeps you holding on to stocks in this sector?

What investing strategy do you use to protect your investments from a recession?