The 1 Stock You've Been Overlooking for Your Roth IRA
Conventional wisdom might cause you to overlook this wealth-building machine.
You may not be able to define luxury, but chances are that you know it when you see it. Luxury goods are the opposite of necessities. They’re high-end products that consumers want but don’t need, and they are also distinct from commodity products such as bananas or gasoline that are not easily distinguished by brand.
Luxury goods are more expensive than competing products, but they are perceived as higher quality and thereby confer status onto the owner. Because of that relationship, brand is a crucial component of a luxury stock.
The best luxury stocks include strong brands, high operating margins, and timeless products.
Being non-necessities, luxury goods resemble high-priced discretionary goods, making them the opposite of consumer staples, or everyday products such as groceries that consumers buy because they need them. While luxury goods may sometimes be durable goods like cars, they can also be consumables like cosmetics or cigars.
Investors most often think of retail products when they think of luxury. Those may include fashion from brands such as Burberry Group (OTC:BURBY); Jimmy Choo, which is owned by Capri Holdings (NYSE:CPRI); or Stuart Weitzman and Kate Spade, which belong to Tapestry (NYSE:TPR). However, the sector spans beyond retail into travel, food and dining, and even services.
The chart below shows some of the top luxury stocks you can buy today.
|RH||(NYSE:HR)||A retailer of upscale furniture and home goods|
|LVMH Moet Hennessy Louis Vuitton||(OTC:LVMHF)||World’s largest luxury company spanning multiple|
|Ferrari||(NYSE:RACE)||Maker of luxury sports cars|
All three of these stocks have outperformed the S&P 500 (INDEX: ^GSPC) by a wide margin in recent years, benefiting from a bull market, an expanding global economy, and increasing wealth among upper-class consumers.
RH, the company formerly known as Restoration Hardware, has mastered the market for expensive home goods. The company sells items like $5,000 dining tables and $8,000 leather couches based on a modern and contemporary design motif. RH uses mailed source books and thick catalogs to stimulate demand, and it sells its wares from a handful of splashy galleries across North America. Under the leadership of CEO Gary Friedman, the company successfully pivoted to a membership model, selling annual memberships at $100 in exchange for 25% discounts on merchandise. That has encouraged repeat purchases and customer loyalty.
LVMH is the world’s biggest luxury company and is valued at more than $300 billion. The company has diversified holdings in wine and spirits, luxury fashion and leather goods, perfumes and cosmetics, and jewelry and watches, among other businesses. In recent years, much of the company’s growth has come from mainland China, where an emerging upper class and a culture of conspicuous consumption has supported growth across much of the luxury market.
Like most luxury companies, LVMH saw revenue decline in 2020 due to the impact of lockdowns and the coronavirus pandemic, but it returned to profit growth by the second half of the year boosted by strength in China, which recovered from the pandemic faster than the rest of the world.
Ferrari, the high-end sports car maker, employs a classic luxury-selling technique. The company limits its production in order to support high prices and wide operating margins. Artificial scarcity, as this strategy is known, helps create demand for the product as it becomes exclusive, and, therefore, a status symbol. Since not everyone can have one, people naturally want it more.
Ferrari’s own management has argued that the company should be valued more like a luxury company than an automaker, and it earns a higher multiple than its auto sector peers. Like LVMH, the company has found a ripe market in China, and it’s burnished its profits by selling limited-edition cars at prices above $1 million.
Luxury companies are distinct from most companies in a number of ways, especially in the relationship between desirability and price, and there are some important differences in analyzing luxury stocks.
Because rapid growth can dilute a brand, especially if that growth is coming from a mid-market customer base, high revenue growth is rare for a luxury company and is not the most important quality to look for. Investors should consider the strength of its brands, which can often be measured by a company’s pricing power, or how expensive its items are compared to competitors’. Operating margin is the most important metric because it shows how successful the business is at converting revenue into profit. Investors should expect luxury companies to generate high operating margins. Twenty percent or more is ideal here.
While investors tend to think of companies like LVMH, Hermes (OTC:HESAY), or Cartier-owner Kering (OTC:PPRUY) as core luxury brands, luxury status extends beyond fashion and retail, and some companies have elements of a luxury business inside a larger one. Nike’s (NYSE:NKE) Jordan brand, for instance, uses the same kind of artificial scarcity to drive sales of its basketball sneakers, which often fetch top dollar on the resale market. Starbucks (NASDAQ:SBUX) has followed a similar playbook with its reserve roasteries and premium coffees, and Airbnb (NASDAQ:ABNB) offers luxury home rentals through Airbnb Luxe. Apple (NASDAQ:AAPL) and Tesla (NASDAQ:TSLA) also serve as examples of companies that have successfully straddled the luxury and mass markets.
For investors looking for an easy way to get exposure to a broad range of luxury stocks, the best way to do so is through an ETF, or an exchange-traded fund. The one that tracks the S&P Global Luxury Index (INDEXSP:SPGLGUN) is the Ammundi S&P Global Luxury ETF (GLUX.MI), which trades on a number of European exchanges.
The top-10 holdings in the S&P index and the Ammundi ETF are Tesla, LVMH, Kering, Richemont (OTC:CFRUY), Daimler (OTC:DDAI.F), Estee Lauder (NYSE:EL), Hermes, Nike, Pernod-Ricard (OTC:PDRDY), and Diageo (NYSE:DEO). As you can see, the list comprises a range of consumer products, including fashion, cosmetics, alcohol, and autos.
The luxury sector has been a strong performer over the past decade, but it is susceptible to market pullbacks and recessions. Consumer spending on these products tends to fall in difficult times as the ranks of the wealthy are diminished.
The COVID-19 pandemic has had an impact on the industry, disrupting manufacturing and supply chains at times, restricting tourism, making in-store purchases difficult, and hitting certain sectors like fashion especially hard. However, some luxury brands have thrived during the pandemic, such as Tesla, and others have seen strong growth, thanks to China.
Many of the world’s most powerful brands are luxury companies, and such brand power brings significant competitive advantages and wide profit margins with it. Therefore, luxury stocks have a place in almost any portfolio.
These stocks have a history of outperforming the broader market, and the sector is made up of companies that have proven themselves, making it relatively low-risk. Although they are cyclical, a number of trends favor luxury stocks over the longer term, including the emergence of the luxury goods market in China and an expanding wealth class in the U.S. and Europe, which has increased the market for luxury goods.
The drivers of luxury demand, such as the desirability of exclusivity and status, are also timeless, meaning this sector should continue to beat the market over the long term as well.
Conventional wisdom might cause you to overlook this wealth-building machine.
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