6 Hot Consumer Discretionary Stocks for 2014

There is a mountain of evidence that suggests that investors should stay away from discretionary stocks. High unemployment rates, stagnant wages, and a worrying precedent of working-age Americans being the primary beneficiaries of food stamps all point to an economy in the doldrums.

However, all of that has not stopped Americans from spending. At a staggering $3.04 trillion, consumer spending has jumped 22% from where it stood three years ago. Total household debt exceeds $13.0 trillion and is close to touching pre-recession levels. U.S. GDP grew at a blistering 3.7% pace in the second half of 2013, the fastest pace since 2003.

Fairly priced consumer-goods stocks are historically known to be strong performers. The S&P 500 Consumer Discretionary sub-index was the S&P 500's best-performing sector in 2013. The SPDR S&P Retail ETF gained 41.3% in 2013, while the Market Vectors Retail ETF shot up 38.6%. Meanwhile, the tech-rich NASDAQ Composite was up 33.9% during the year, while the S&P 500 gained 26.5%. Although the S&P 500 Consumer Discretionary is down 6.5% year-to-date, it's still up 23% year-on-year.

To pick stocks in this sector that have shown consistently good performance over the past few years, I used the following parameters:

• A trailing P/E ratio below the industry median
• Positive quarterly earnings growth that's above the industry median
• Positive normalized earnings growth calculated on a three-year basis
• Better stock returns in the last twelve months than the broader S&P 500

Automobile sector
Many stocks in the automobile sector have been performing quite well. While there is a lot of debate about whether or not the rather flat U.S. consumer-discretionary spending signals a cooling economy, big-ticket and interest rate-sensitive items such as automobiles do not follow the same rules as, say, casual dining. People are not paying cash for their cars, but are instead relying on the prevailing low interest rates to finance their purchases.

It's therefore not surprising that many stocks in this sector are doing so well.

Despite their impressive gain in 2013, Meritor (MTOR) has continued to perform well this year, with shares up by a huge 9.1% in late January after the company comfortably beat the consensus earnings estimate. The main highlight of the company's latest earnings release was the 720% rise in quarterly net income from $5 million to $41 million. The company also reaffirmed its earnings guidance for the current year.

Asbury Automotive Group (ABG -2.00%) is one of the most endearing growth stocks in the auto industry. Its bottom line grew 33.7% last year, and the company has hiked its earnings estimate for 2014. Although the firm's EPS growth this year is expected to come in lower at 12.3%, the long-term (four-year) growth forecast calls for a healthy 25.7% growth.

Thor Industries (THO -2.81%) is a manufacturer of recreational vehicles, or RVs, and it mainly produces motorized RVs and towable RVs. Motorized RVs are seeing off-the-scale demand and players in this space, including Thor's competitor Winnebago, are seeing huge increases in motorized RV sales along with huge order backlogs. Thor recorded a 45% pop in motorized RV sales last quarter. 

Lithia Motors sells new and used car parts. Its share price has dropped by close to 20% this year, mainly due to weak December vehicle sales. The firm's solid growth track record, however, makes its shares compelling candidates for the bargain bin. Lithia has seen its revenue grow in the last four years, and its top and bottom lines in 2014 are expected to grow at 11.5% and 12.8%, respectively. The relatively utilitarian nature of its business in comparison with major auto companies such as GM and Ford presents a lower-risk way to play the automotive sector.

Other interesting picks
There are other companies outside the auto sector that easily pass the screener:

Viacom (VIAB) has been very strong on share buybacks and dividend payout, which signals robust growth in the company. The movie-maker repurchased $4.8 billion worth of shares in 2013, and it has increased its stock buyback program from $10 billion to $20 billion.

Viacom plans to launch a programmable children's TV channel that parents can use to choose the particular programs they would like their children to watch in the style of Pandora and Netflix.

Sturm, Ruger & Company (RGR -0.41%) is a firearm manufacturer. The company's share price has dropped about 15% this year on concerns that industry-wide demand for firearms might be shrinking, as well as the company's recent decision not to sell semi-automatic firearms in California. The company recorded an impressive 45% sales growth in the second half of 2013, which suggests that it might be eating its competitors' lunch as far as firearm sales go. The latest decision by the company to buy back its stock ironically caused a panic and triggered a sell-off, as investors took it to mean that the company expected 2014 to be a tough year so it was trying to buy investor loyalty.

Ruger, however, has a good history of sound capital allocation, which is clearly evidenced by its fluctuating EPS which usually comes in at around 40% of net income. Judging from Ruger's strong sales, it's more likely than not that the firm's foregone sales in California will be made up for in other regions.

Final Thoughts
By digging deeper into the consumer-discretionary sector and doing due diligence, investors can find promising stocks that look like fair bets to deliver in 2014, or withstand market vagaries if the broader market takes a nosedive.