Consumer discretionary is a term for goods and services that are non-essential products. For example, rice and wheat would be considered essential items. Meanwhile, cars and streaming services are non-essential products.
Consumers will only buy non-essential items when they have enough income left at the end of each month to afford those products. While consumers might want new clothes or durable goods, they will avoid buying them if they are unable to financially. These type of products and services are called consumer cyclicals or consumer discretionaries.
Consumer discretionaries are important because they show the strength of the economy. In total, consumer spending makes up 70 percent of the United States gross domestic product (GDP). When the economy is growing, consumer discretionaries sell more products and services. If the economy is weakening, these companies sell fewer products.
How It Works
A consumer discretionary does better during economic expansions. When the economy shrinks, people are unlikely to spend their money on non-essentials. During a strong economy, people earn more money. This means they have discretionary income to spend on non-essential items.
Each economic cycle influences consumer spending and labor earnings. Investors can look at the overall economy to determine whether they want to invest in consumer discretionaries or not. They can also use consumer discretionaries to understand how the economy is doing.
When people do not have enough money, they tighten their budget and cut out unnecessary expenses. New cars, restaurant meals and luxury clothes are all examples of discretionary products. During an economic contraction, people cut back on non-essential items. This is because they do not have enough disposable income to afford these products.
What Are Consumer Discretionary Stocks?
Consumer discretionary stocks rely on customers spending money when they do not need to buy anything. The following businesses are examples of consumer discretionaries:
- Cruise lines
- Automobile manufacturers
- Companies that sell luxury goods
- Apparel businesses
- Furniture sellers
- Manufacturers of consumer electronics
- Department stores, computer sellers, auto dealers and other retailers
- Hotels and resorts
- Makers of housewares, appliances and home furnishings
- Creators of auto parts, tires and accessories
- Sellers of consumer services
Consumer staples are different than consumer discretionaries. Household goods, food items, hygiene products, alcohol, tobacco and beverages are all examples of consumer staples. Because these items are considered essential, they are impervious to economic fluctuations. No matter how bad the economy gets, people will still spend money on food because they have to eat something each day.
In comparison, consumer discretionaries can be removed from your budget during a recession. As soon as the economy begins contracting, investors will often sell their consumer discretionaries and buy consumer staples stocks. They may also buy low-risk investments, like United States Treasuries and corporate bonds. Once the economy improves, investors will normally start buying consumer discretionaries again.
The State of the Economy
Economists use consumer discretionary companies to judge the state of the overall economy. It is just one of several tools economists use to determine how the economy is doing. An investor can use economic indicators to predict if consumer discretionaries will rise or decline in value. The following indicators can also tell you a great deal about the overall state of the economy.
- Consumer confidence: Consumer confidence represents the way consumers feel about the economy. If consumers are pessimistic about the future, they may hold off on buying a car or taking a vacation. Because this causes consumer discretionaries to lose revenue, these companies are likely to report fewer sales. Before long, this trend can also cause an economic contraction.
- Interest rates: The Federal Reserve uses interest rates to guide the marketplace. When interest rates are high, borrowing costs increase. This naturally encourages companies to save more and borrow less. The Federal Reserve increases interest rates to reduce inflation and to prevent bubbles. To stimulate the economy, the Federal Reserve decreases interest rates. Investors can normally tell if the economy is going through a contraction by looking at changes in the Federal Reserve’s interest rates.
- GDP: GDP is a useful metric for understanding the overall economy. If the economy is improving, GDP will increase. When this happens, people generally spend more money on consumer discretionaries.
Investors follow many indicators to determine the value of consumer discretionaries. They may look at unemployment levels, home sales, retail sales, building construction activity and non-farm payrolls. Labor market hours, manufacturing activity, earnings and service activity also play a role.
The Best Consumer Discretionary Stocks
If you want to invest in this sector, there are a few different ways you can get started. The following are some of the best stocks in this sector in 2021.
- Etsy: Etsy is one of the fastest-growing stocks in this sector. This company sells vintage goods, handmade items, housewares, art and similar products.
- eBay: eBay currently has one of the best values of any stock in this sector. This global marketplace helps buyers and sellers interact in 190 markets. It currently has a P/E ratio of 19.14.
- Thor Industries: Thor is another one of the fastest-growing companies in this sector. This company sells motorhomes and camping trailers to customers in Canada and the United States. According to a study by Thor Industries, 73 percent of RV renters said they are likely to buy an RV soon.
- Tesla: Tesla is known for its electric vehicles, and the stock has excellent momentum. The trailing total return for the last 12 months is currently at 381.7 percent. In just the first quarter of 2021, Tesla made more than 180,000 vehicles.
- Capri Holdings: Based in the United Kingdom, this company sells apparel and accessories. Through its subsidiaries, the company sells shoes, boots, handbags, watches and sunglasses.
- Genuine Parts: This company sells replacement parts for vehicles and industrial purposes. They also sell electronic materials and office products to clients in Canada, Mexico and the United States. Genuine Parts is one of the fastest-growing companies in the consumer discretionary sector.
- Nike: Over the years, Nike has developed a dominant position in the athletic apparel industry. Its market share is currently between 25 and 30 percent. Thanks to its expansion into global markets, it is poised for growth in China and other fast-growing regions.
The Best Consumer Discretionary Stocks continued…
- Walt Disney: Walt Disney owns ABC, Pixar, Marvel, Star Wars, ESPN and a chain of theme parks. Because it owns a lot of intellectual properties, it can sell a range of toys and live entertainment based on its characters. While the pandemic hit Disney’s theme parks pretty hard, Disney+ has made significant gains. Disney+ now has 70 million subscribers each month.
- Starbucks: Starbucks is known for its coffee beverages, and it has developed a loyal following around the world. By the end of 2020, Starbucks had more than 33,000 locations around the world. By 2030, the corporation expects this number to grow to 55,000 locations.
- McDonald’s: McDonald’s has managed to adjust to changing times with automated kiosks, digital menus and mobile orders. Plus, McDonald’s shares have a payout ratio of about 60 percent. Investors love McDonald’s because it consistently pays dividends.
- Amazon: Amazon has a market capitalization of $1.748 trillion. As the most dominant e-commerce platform in the world, it sells a range of consumer goods. In 2021, Amazon’s revenue is expected to grow by a whopping 35 percent. Because of this impressive level of growth, analysts expect Amazon’s share price to increase by an additional 20% in the upcoming year.
- General Motors (GM): While GM hit a low point in March 2020, the stock tripled in value by the end of the year. GM’s self-driving technology and push for electric vehicles have placed it at the forefront of the American auto industry. The corporation might not be as flashy as Tesla. But they are still a solid company and have a lot of growth possibilities.
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Consumer discretionaries are available in a variety of industries. While hospitality is a popular sector, you can also buy restaurant, automobile and clothing stocks. As long as the economy is advancing, these stocks will generally perform well. Because of this, investors often buy these stocks when they expect an economic expansion. If they think the economy is about to undergo a contraction, they will sell their consumer discretionaries.
When it comes to consumer discretionary stocks, look no further than our Trade of the Day e-letter. Each week Bryan and Karim highlight a different company. Many of these fall under the consumer discretionary sector. Sign up today and start making smarter, more profitable investments.
Ben Broadwater is the Director of Investment U. He has more than 15 years of content creation experience. He has worked and written for numerous companies in the financial publishing space, including Charles Street Research, The Oxford Club and now Investment U. When Ben isn’t busy running Investment U, you can usually find him with a pair of drumsticks or a guitar in his hand.