The consumer discretionary sector is comprised of companies offering goods and services that are discretionary (non-essential) for their customers. Consumer discretionary companies run businesses such as: retail stores, casinos, restaurants, travel, entertainment, toys, and autos.
The discretionary sector offers high potential investment returns because discretionary companies often have higher growth rates than seen in other sectors of the stock market. However, it also presents more investment risk as the sector is more sensitive to changes in the overall economy.
Generally speaking, consumer stocks will do well in a rising economy when consumers have surplus disposable income, but they suffer more than other sectors during a recession, when consumers are forced to cut out unnecessary spending.
This makes sense, as people are going to continue paying their water and electric bills (Utility & Water Sector), buy groceries (Consumer Staples Sector), and take their medications (Healthcare Sector), but they may give up their other luxury spending if finances require it.
This relationship is clear when looking at the sector returns over the last decade (courtesy of Novel Investor):
You can see that the S&P 500 Consumer Discretionary Index outperformed the index during every year but 2007 and 2016. However, it did lag the “safe” sectors such as Consumer Staples, Health Care, Utilities, and Telecommunications during the 2008 recession.
Consumer Stock Examples
With the overall out-performance by the discretionary sector, one would expect to find some successful companies in the group. The key is identifying those companies early in their growth phase and then holding them for long periods of time. This can create some outstanding total returns on your investment.
Starbucks has been around for a long time, continuously expanding its reach as the dominant name in the coffee business. In doing so it has grown earnings at a greater than 21% annualized rate over the last two decades.
Notice that the only year Starbucks did not have positive growth was in 2008, during the “Great Recession”, which goes back to the point that consumer discretionary stocks are impacted by the overall economy.
This secular growth story resulted in outstanding total returns for early buyers of the stock, turning a $10,000 investment into a $235,000 nest egg with dividends reinvested.
Lowe’s Companies is another consumer discretionary stock that has performed well, growing earnings at a 15%+ annual rate over the last 20 years.
However, Lowe’s is a home improvement store, so its business is more affected by a weak economy. This was seen during the recession, when the housing market crashed and caused Lowe’s earnings to decline.
This is seen on the F.A.S.T. Graph below, which shows that Lowe’s had negative earnings for 2008, 2009, and 2010 before returning to strong growth from that point forward.
However, despite a few years of negative growth, the overall high earnings growth rate resulted in 15.8% annualized total returns, turning a $10,000 investment into $191,532 over two decades with dividends reinvested.
Not only did Starbucks and Lowe’s offer high capital gains returns, but they also rewarded investors with a steadily increasing dividend which resulted in some impressive yield on cost “YOC” numbers at the end of the period.
Investors who bought Lowe’s 20 years ago are now receiving 34% of their initial capital back in dividend payments, and for those in Starbucks, nearly 36%.
This high income return comes despite low or non-existent yields at the time of initial purchase. Dividend reinvestment plus high growth rates can create some impressive compounding over the years!
Top Dividend Growth Stocks From The Consumer Discretionary Sector
Starbucks and Lowe’s are just two examples, but there are plenty of other excellent companies in the sector. The type of companies that have produced long track records of earnings and dividend growth, and high total returns for shareholders.
Over the last few years I have used David Fish’s U.S. Dividend Champions spreadsheet to find the top dividend growth stocks from different sectors of the market, and then created watch lists of those companies to use when I have cash available for new purchases.
These watch lists allow me to quickly see where companies are trading in comparison to 52-week highs, and also provide a quick comparison of the dividend yields and valuations of each member..
Here is a spread-sheet showing the companies on my watch list for the consumer discretionary sector.
Here is a PDF version of the consumer discretionary stock list.
As market conditions change, I periodically update my master list and then write articles highlighting what I see as the best opportunities at current prices.
It has been a while since I’ve updated my thoughts on the discretionary stocks, but here is a link to the original article on Seeking Alpha from December 1, 2015.
Return to Sector Watch Lists.