Professor Bainbridge...on law, politics, religion, culture & food

Beer Stocks and Systematic Risks

George Will:

Perhaps, like many sensible citizens, you read Investor’s Business Daily for its sturdy common sense in defending free markets and other rational arrangements. If so, you too may have been startled recently by an astonishing statement on that newspaper’s front page. It was in a report on the intention of the world’s second-largest brewer, Belgium’s InBev, to buy control of the third-largest, Anheuser-Busch, for $46.3 billion. The story asserted: “The [alcoholic beverage] industry’s continued growth, however slight, has been a surprise to those who figured that when the economy turned south, consumers would cut back on nonessential items like beer.”

Will then launches into an erudite but irrelevant history of beer making. Let’s stay on topic.

Financial economists tell us that risk and return are positively correlated. The more risky an investment, the higher the return it must pay to attract investors.

Financial economists distinguish between two basic types of risk: unsystematic risks, which are risks associated with a particular firm (e.g., the CEO dies or the plant burns down); and systematic risks, which are risks associated with the market as whole, such as recessions.

Portfolio theorists tell us that the return on stocks is solely a function of the stock’s sensitivity to systematic risks. This is so because you can eliminate unsystematic risk via diversification. (See A Random Walk Down Wall Street for a highly accessible explanation.)

Manufacturers of consumer durables such as cars are very sensitive to systematic risk. During economic downturns, people put off purchases of expensive durable products, hoping to squeeze a few more years out of their old jalopy. In contrast, manufacturers of consumer non-durables, such as food, are much less sensitive to systematic risk. This is so because people have to keep eating and, by definition, you can’t stretch a can of soup very far before you have to replace it.

Manufacturers of addictive recreational drugs ought to be especially immune to systematic risk. If I smoke and drink, worry about economic conditions may make me nervous, which I may assuage by smoking and drinking more!

In fact, during the last major recession, American beer consumption went down slightly. Very slightly.

Take the last recession, which lasted from March to November 2001, according to the National Bureau of Economic Research.

Domestic beer shipments dipped only one-sixth of a percentage point that year, according to data from industry consultant Robert S. Weinberg, a former A-B executive. The average American adult’s beer consumption fell by just four ounces, to 31 gallons, in 2001.

In technical terms, “the income elasticity of beer is extremely low,” said Baker — meaning changes in personal income have little impact on the amount of beer consumed. Beer is still cheaper than it was 10 years ago after adjusting for inflation.

Food and beverages are usually some of the last spending categories to be severely affected by a downturn, said Lauren Torres, an equity analyst who covers Anheuser-Busch for HSBC.

Instead of reducing consumption, people are more likely to switch to a less expensive beer. Instead of InBev’s Stella Artois, they might switch to Anheuser-Busch’s Bud.

In other words, beer stocks are a good place to park your money during a downturn. Investors Business Dailty may not tell you that. George Will may not either. But I will.

Of course, I’ll be sticking to wine, but that’s another story entirely.