3 "Diamonds" Hiding Inside the Battered Consumer Staples Sector

Key Points

• Despite its reputation for resilience, the consumer staples sector has been among the worst performing groups all year.

• Among the laggards, several high quality "diamonds" can be found.

• Although a rate cut cycle is underway, the case can still be made for keeping some exposure to defensive stocks.

• 10 stocks we like better than Walmart ›

Whether you're looking at the past month, or the past year, the S&P consumer staples sector (NYSEMKT: XLP) is either at -- or near -- the bottom of the performance list. This is especially noteworthy, I would argue, since the group's slump has coincided with a period of substantial economic uncertainty. Even so, Koyfin data shows that 35 of the 50 stocks in this traditionally defensive sector have been largely shunned by investors this year, with only a few standout exceptions delivering positive 1-year returns.

How bad is it? As of September 18, Koyfin data shows the consumer staples sector is down 2.8% in the past month, and down 2% from a year ago, at a time when the S&P 500 has gained 3% and 19.2% respectively.

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Historically speaking, this type of wholesale rejection typically results in some high-quality companies being taken down alongside their out-of-favor peers.

With that in mind, I dove into the consumer staples sector and unearthed what I am calling 3 diamonds in the rough that total return investors should own for the long term. To get there, I used the following formula:

• Positive 1mo, 3mo, YTD and 1Y total returns pays a dividend

I wasn't sure how it would play out, but by the looks of it, the results are something you can sink your teeth into. Let me explain.

Image source: Getty Images

Diamond #1-Walmart

With its 3%, 9%, 15% and 32% respective returns over the past 1 month, 3 month, YTD and 1 year periods, as well as its current 0.9% dividend yield, retail giant Walmart (NYSE: WMT) was the first defensive diamond to make the cut.

It's worth noting that the $820 billion Arkansas-based company is the largest stock in the consumer staples sector, and therefore also carries the largest weighting within the group, where it currently accounts for 10.4% of the index.

With over 5,200 domestic retail stores, an e-commerce business, Sam's Club division, and large international footprint, Walmart's breadth of products -- especially groceries -- along with its hyper-focused commitment to everyday low prices, make it a fierce competitor in any economic environment.

That said, Walmart's stock is not cheap and currently trades at 37x expected earnings over the next 12 months, Koyfin data shows.

However, at a time when consumers are feeling the pinch of inflation, worrying about their jobs, and generally tightening their belts, the fact that Walmart is bucking the broader slump in staples is understandable, and deserving of its outlier performance and multiple.

Diamond #2-Archer Daniels Midland

With over 120 years of experience weathering economic cycles, Archer-Daniels-Midland (NYSE: ADM) has grown to be one of the world's largest players in the agricultural supply chain. Whether it's procuring, processing, transporting or storing commodities, Chicago-based ADM is deeply involved in the global production of food, both for humans and animals.

ADM's pedigree and track record are apparently not going unnoticed within the staples sector, as Koyfin data shows the $29 billion multinational is currently printing 3%, 13%, 24% and 5% total returns respectively for the the 1mo, 3mo, YTD and 1year periods.

There's also the fact that ADM currently carries a 3.3% dividend yield, which the company pointed out it has now paid for 375 consecutive quarters, or more than 93 years.

In fairness, ADM's management pointed out in its Q2 earnings call on August 5th, that "limited clarity on legislative and biofuel policy" continues to impact margins in reference to a changing ethanol environment.

Still, come the end of the day, people and animals always have to eat, so no matter what happens economically speaking -- at home or abroad -- ADM will continue to be a central player in this sector.

Diamond #3-Sysco

As I said earlier, this "defensive diamonds" theme is something you can sink your teeth into. Along with low-priced food (and goods) from Walmart, improved edible commodity yields and ingredients from ADM, there's an enormous market out there for meals made outside the home. That's where Sysco (NYSE: SYY), the $39 billion self-titled global leader in foodservice distribution comes in.

In terms of its "diamond status", Koyfin data shows shares of Sysco are up 3%, 11%, 9% and 13% over the 4 periods I measured, plus it also has a respectable 2.6% dividend yield. As a bonus, it also generates $1.8 billion in free cash flow, and expects to do $1.3 billion of share repurchases this year, CFO Kenny Cheung said on the company's fiscal Q4 earnings call in July. .

Also worth noting, Koyfin data shows that 10 of 18 analysts (55%) who cover Sysco currently rate it a "Buy" or "Strong Buy", with an average 12-month price target of $86, which is about 5% above current levels.

Strength among weakness

To be sure, the consumer staples group has struggled this year, but Walmart, ADM and Sysco have each proven their resilience in terms of dividends and returns. While each currently carries risks ranging from stretched valuations to cyclical slowdown exposure, a long-term investor looking for steady, high quality companies should feel good about looking for an entry point to add these defensive names as a core holding.

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The Motley Fool has positions in and recommends Sysco and Walmart. The Motley Fool has a disclosure policy. Matthew Nesto does not have a position in any of the stocks mentioned.