Consumer brands are all around you, and so are the investment opportunities and ideas that come from these companies. Whether it's Gillette shaving cream or Jello pudding that gets your gears going, there are three key factors to consider when looking to invest in a consumer brands company.

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By Robert Fredeen

Consumer brands are among the best-known companies on Earth. For a variety of reasons, the companies that own the brands have convinced people that their products are better than their competitors', and people are willing to pay a bit more for these products.

Looking for these types of companies can be very easy. For instance, look at the shoes on your feet. Perhaps you are a big Nike (NYSE: NKE) fan, so you can look at Nike as a possible investment. Other consumer brand companies require a bit more effort to figure out. If you really love using Tide to wash your clothes, and you would like to invest in the manufacturer, you need to find out that Tide is owned by Procter & Gamble (NYSE: PG).

Investing in consumer brands is one of the easiest ways to buy what you know, since most of us eat food, buy soap, and wear shoes with brand names attached to them. Investigating these companies often strikes close to home as you learn more about the products you use every day.

Consumer brands are middlemen
There are a few points to remember about consumer brands. First, these companies are usually some kind of middlemen. They stand astride their respective industries, taking raw, semi-finished, or even finished goods from manufacturers, then distributing those items to retailers or other companies. While each industry has its own peculiarities, the basic point is that consumer brands are in the middle of their industries, not at one end. This fact weighs heavily on how to evaluate these companies.

Marketing is important
Second, marketing is a crucial factor in the success or failure of a product. Unfortunately, marketing is notoriously hard to measure, and it seems the effectiveness of an advertising campaign doesn't show up until the company has poor sales the following quarter.

Distribution channels and what they mean
Third, because of their position as middlemen, consumer brands companies must work to create distribution channels. By distribution channel, we mean the way a company gets its products out to consumers. Stronger companies have larger, more diverse distribution channels, which helps them fend off the inevitable problems that strike industries from time to time.

Let's look at these three points individually.

It all starts with marketing
Many, if not most, consumer brand companies live and die by the strength of their brands. This isn't just about how much money they throw at advertising campaigns. Brand value is built when companies live up to their promises to customers. One key point here is that companies need to produce good products that people want to buy. Another is that the companies need to build awareness for and explain their brand value to customers in a way that translates into sales and brand preference.

Effective marketing is all about communication. Marketing campaigns need to communicate to the target audience how the brand is better than its competitors. And, like most communication, marketing needs to start with the basics -- explaining what the product is and how it's better for consumers before diving into cool, esoteric ads.

There are many ways to convey a brand's message to consumers, and several media outlets to use. It's important to judge a marketing campaign on how well the message fits the medium. For example, ads for websites often do not work on television. There are two big reasons for this. First, the brands are too young and don't have the mindshare in the TV-watching population for the marketing to make much sense. Second, TV tends to be a passive medium (just think of the negative nicknames associated with TV), while the Internet is interactive to its very core. It's possible for companies to bridge these differences, but it is also complicated.

All of this communication will be for naught, however, if the company and product fail to live up to their promises. Also, when problems arise, companies need to handle them resolutely and honestly. The classic example is Johnson and Johnson's (NYSE: JNJ) handling of the Tylenol cyanide scare in the 1980s. The company moved quickly and resolutely to remove the potentially tainted products from store shelves, and put better safety measures in place. Providing a good product is an important part of building the brand. Standing by that product and quickly fixing problems is critical to maintaining the brand.

The one thing marketing cannot do is confuse consumers. If the advertising campaigns talk about value, the products shouldn't sport luxury prices. If the brand is focused on winning athletes, the company should shy away from non-sports-related marketing. This confusion can muddle the brand's image and cause people to identify with it less. The result of fewer people identifying with a brand is usually falling sales and profits -- not something we like to see in an investment.

Marketing needs to be a core strength of a consumer brand company. So, investors need to find companies that both understand their brands and work hard to support them. The marketing needs to explain to consumers what the products do, and it needs to be clear on what the company, brand, and product stand for. Giving consumers something to identify with is the most important role of marketing.

Deep distribution channels
Distribution channels are critical to consumer brands because few of these companies own significant retail real estate. They must have deals with retailers. The more retailers that carry their products, within certain limits, the more people have the opportunity to buy those products.

Let's explain one point about distribution, though. Not every retailer is desirable. If your brand focuses on high-class luxury goods, it's not a good idea to sell them at Wal-Mart (NYSE: WMT), no matter what the terms of the deal are. Part of the allure of luxury brands, in fact, is their relative scarcity. Wal-Mart is not a luxury-goods retailer, so putting these items up for sale there will be useless, if not bad for the brand. Instead, companies need to cut deals with retailers that target a similar market as the company.

Other than that, distribution is key. Looking at companies like Proctor & Gamble and Kraft Foods -- owned by Philip Morris (NYSE: MO) -- huge distribution networks are the keys to these companies' success. They are able get their goods into the largest retailers, making their products accessible to virtually every consumer in the U.S. and much of the world. This means that when they have a new product, these companies can easily and cheaply deliver them to all of their existing accounts.

As much as I hate to use buzzwords, the benefit of a large distribution channel is all about leverage. When a company has several brands under its control, it is in a stronger position to persuade retailers to carry its brands. It is far cheaper to add a crate of Pampers to the usual weekly Tide delivery than to send a new truck of diapers. Also, companies can cross-promote items, as PepsiCo (NYSE: PEP) does with its beverages and Frito-Lay snack products. By linking brands in different product lines, companies may be able to improve their market share in each product category.

For most consumer brands, it is critical that the goods are displayed prominently at retailers. This can help cut costs, improve overall sales, and increase market share.

In the middle
Being in the middle of their industry presents consumer brand companies with some great opportunities as well as challenges. We'll start with the challenges. We covered the importance of distribution channels above. However, these same critical relationships can be a source of risk for consumer brand companies as well.

A prime example is Nike. As the footwear retail industry expanded in the mid-1990s, Nike was performing very well. Unfortunately, this expansion turned to over-expansion, and retailers started to suffer from high inventory levels. With the retailers suffering, Nike suffered as well. Products weren't moving, so retailers didn't have the space or the money to buy new Nike shoes, hurting Nike's sales in 1998 and 1999. It wasn't until 2000 that the industry started to recover -- and with it, Nike's business.

So, problems at related players like retailers can reverberate up through the industry, hurting sales and profits at the consumer brand companies that are in the middle. Many consumer brand companies find themselves unable to completely control their destiny because of problems downstream from them. It's easier to pay attention to this issue in relatively simple industries like footwear. Other industries may be more difficult.

However, this potential problem is offset by a benefit that strong consumer brands frequently enjoy: They can often get customers to pay them faster than they have to pay their suppliers. One way to check this is to calculate the Foolish Flow Ratio for a company, which originated in our Rule Maker portfolio. We define the Flow Ratio as:

       (Current Assets - Cash)
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(Current Liabilities - Short-term Debt)