Investing in Top Consumer Discretionary Stocks

Updated: Oct. 5, 2020, 4:18 p.m.

When it comes to shopping, there are things you need, and there are things that are more nice to have. The consumer discretionary sector covers that second category, the goods and services people spend money on when they have a little extra cash available.

Unlike consumer staples companies -- which make the bare necessities -- consumer discretionary stocks tend to do well when the economy is strong and people have more money, and poorly when times are tough and it's harder to make ends meet, like during the coronavirus pandemic. Below, we'll look more closely at this part of the stock market and show you some top consumer discretionary stocks to consider.

What are consumer discretionary stocks?

Consumer discretionary stocks cover several different industries, but the one thing they have in common is that they all involve businesses that count on consumers spending money they don't need to spend. They include the following types of businesses:

  • Manufacturers of cars, trucks, and motorcycles
  • Tire makers and producers of auto parts and equipment
  • Homebuilders
  • Makers of furniture, appliances, housewares, and other home furnishings
  • Consumer electronics manufacturers
  • Apparel and luxury goods companies
  • Retailers of various kinds, including department stores, home-improvement retailers, computer and electronics retailers, home furnishings sellers, apparel stores, auto dealers, and specialty retailers
  • Direct-to-consumer retailers that sell goods by catalog, mail, or over the internet via e-commerce
  • Hotel, resort, and casino operators
  • Restaurant companies
  • Cruise operators
  • Providers of consumer services, including education

The fact that consumer discretionary stocks tend to rise and fall with the overall economy makes them cyclical stocks. In analyzing the sector to find the best consumer discretionary stocks, it's therefore important not just to look at recent performance, but also to consider how each company did over the course of the most recent economic cycle, which includes the coronavirus pandemic.

COVID-19 has hit the consumer discretionary sector especially hard, as many of these businesses either can’t operate during the pandemic or are operating at a diminished capacity. Among the industries most hurt by the pandemic are travel, restaurants, retail, and entertainment, as these businesses generally require some degree of “social gathering,” which could put customers at risk in the current circumstances. It’s worth remembering that the COVID-19 pandemic is a unique circumstance and different from the typical recession, which merely causes consumers to spend less. Still, it serves as a good example of how crises affect these stocks differently from consumer staples retailers, like grocery stores, that sell necessities and can therefore better manage tough times.

There are several consumer discretionary companies that stand out as being among the best in the business.

Top consumer discretionary stocks

Consumer Discretionary Stock Description of Business
Nike (NYSE:NKE) Athletic apparel and footwear
Starbucks (NASDAQ:SBUX) Coffeehouse chain
McDonald's (NYSE:MCD) Restaurant chain
TJX Companies (NYSE:TJX) Off-price retailer
Booking Holdings (NASDAQ: BKNG) Online travel specialist

1. Nike

Nike (NYSE:NKE) has built up a dominant position in athletic footwear and apparel, with more than half a century of innovation in making sports equipment accessible to a broad consumer audience. The beauty of Nike's business model stems from its use of celebrity sports endorsements, tying the success of athletes to the company's products. Long after Michael Jordan left the professional basketball court, Air Jordan shoes remain a mainstay of Nike's business. Nike’s market share in athletic footwear, recently estimated at between 25% and 30%, puts it well ahead of international competitors Adidas (OTC:ADDYT.Y) and ASICS (OTC:ASCCF). And with the global sportswear company reaching out to play a bigger role in fast-growing areas such as China, the sky's the limit for Nike's future growth.

Though COVID-19 has hurt Nike’s business, the company has built a strong digital ecosystem around apps like SNKRS and the Nike Training Club that has buffered much of the impact of the crisis.

2. Starbucks

Starbucks (NASDAQ:SBUX) has defined how much of the world starts its day, with its ubiquitous coffeehouses sporting lines out the door most mornings at locations across the globe. By introducing the European café concept to the American masses, Starbucks tapped into consumers’ urge to treat themselves to small things, and its premium beverages now have a loyal following the world over. You can see the company’s success in its comparable-store sales, which tell us how its business is growing without new stores. For fiscal 2019, Starbucks’ comp sales grew a healthy 5% worldwide. Those numbers have fallen sharply during the pandemic, but Starbucks is still poised to gain market share thanks to advantages including its brand, tech initiatives, and financial flexibility, as rivals like independent cafés are under much greater pressure.

The company has more than 31,000 locations across the globe as of the first quarter of 2020. Efforts to streamline ordering via mobile device have resulted in shorter wait times, making the Starbucks experience even more enjoyable for its best customers.

3. McDonald's

McDonald's (NYSE:MCD) has come a long way from its heyday in the mid-20th century, and the fast-food colossus has worked hard to keep up with the times. Innovations such as digital menus that automatically change throughout the day, automated kiosks for ordering, online and mobile order capabilities, and delivery options are making McDonald's more accessible than ever. At the same time, the restaurant chain still has an emphasis on value that keeps customers coming back for more, and its drive-thrus have helped it weather the pandemic better than a number of other restaurant chains.

Even in the ever-changing restaurant space, McDonald's has found a way to stay not only relevant, but hip. Investors also like McDonald's for its consistent dividend payments. It has increased those payments to shareholders each year since the mid-1970s, and its payout ratio of around 60% means it can comfortably pay that dividend out of its earnings.

4. TJX Companies

Off-price retail giant TJX Companies (NYSE:TJX) has found success in apparel and home goods with a model that’s not easily replicated online. The parent company of TJ Maxx, Marshall’s, and Home Goods gets discounted brand-name merchandise through closeout sales, manufacturer errors, and order cancellations and then sells it for 20%-60% off.

The model has driven wide profit margins and solid growth over the years, and the company has plans to expand to more than 6,000 stores globally, up from about 4,500 today.

Though TJX took a hit during the shutdown period, customer traffic has come back strong since reopening, and the recessionary environment should help the company capitalize on its reputation for low prices. Meanwhile, the challenges across the retail sector should present the company with plenty of opportunities to scoop up cheap inventory.

5. Booking Holdings

The internet revolutionized the travel industry, and Booking Holdings (NASDAQ:BKNG) was one of the pioneers of online travel. Founded as Priceline Group, Booking Holdings made travel more accessible to the general public through its auction-based "name your own price" tools. The company's acquisition of fellow travel website Booking.com dramatically broadened the geographic scope of its hotel offerings, appealing to international travelers and giving it a competitive advantage over locally based websites. In 2019, the company booked 844 million room-nights across its hotel network.

Though online travel agencies like Booking are clearly challenged by the pandemic, a large part of their costs is marketing, which can be easily adjusted according to demand. That gives Booking an advantage over travel companies with high fixed costs like hotels and airlines, and Booking should be able to ramp up its business as demand comes back.

Focus on the long term

Although the COVID-19 pandemic has created unprecedented challenges for many consumer discretionary companies, investors can still find winners in the sector by focusing on well-known brands and industry leaders. These companies should emerge stronger from the crisis, as they can capture market share from stumbling rivals and raise capital as necessary.

For the moment, demand may be stunted for things like restaurants and travel, but it will come back eventually. Long-term investors can take advantage of the recovery by buying high-quality stocks that are trading at a discount.

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