Investing in Consumer Discretionary

Unlike staples (consumer staples), this sector groups industries that tend to be more sensitive to economic cycles, as they offer goods and services that consumers buy voluntarily when they have additional income.

MSCI

The Consumer Discretionary sector (or Consumer Discretionary) is assigned code 25 within the MSCI GICS structure.

This sector is divided into four main industry groups, with their respective subsectors:

1. Automobiles and Components (Code 2510)

This group includes vehicle manufacturers and the parts needed for them.

• Automobile Components (251010): Manufacturers of parts, accessories, tyres and rubber.

  • Example: Continental, Denso, Magna, Michelin, Bridgestone, etc.

• Automobiles (251020): Includes manufacturers of passenger cars, light trucks and motorcycles. Heavy trucks are excluded, as they belong to the Industrial sector.

  • Example: Toyota, Volkswagen, Ford, General Motors, Honda, Tesla, Stellantis, etc.

2. Consumer Durables and Apparel (Code 2520)

Covers tangible products that typically have a long useful life.

• Durable Household Goods (252010): Includes consumer electronics (TVs, audio), furniture, household appliances and kitchenware.

  • Example: LG, Whirlpool, Electrolux, Williams-Sonoma, Lennar, D.R. Horton, etc.

• Leisure Products (252020): Manufacturers of sports equipment, bicycles and toys.

  • Example: Hasbro, Mattel, Shimano, Peloton, etc.

• Textiles, Apparel and Luxury Goods (252030): Clothing, accessories, footwear and luxury brands such as jewellery and watches.

  • Example: Inditex, H&M, Nike, Adidas, LVMH, Kering, Richemont, Swatch, etc.

3. Consumer Services (Code 2530)

Groups companies that offer experiences or specialised services.

• Hotels, Restaurants and Leisure (253010): Includes casinos, hotels, cruise lines, travel agencies, recreational facilities and restaurants (including fast food and delivery).

  • Example: Marriott, Hilton, McDonald’s, Starbucks, Yum! Brands, Booking Holdings, Expedia, Carnival, Wynn, MGM, etc.

• Diversified Consumer Services (253020): Private education companies and specialised services such as home security, consumer legal services and childcare centres.

  • Example: Bright Horizons, ADT, Laureate Education, etc.

4. Consumer Discretionary Distribution and Retail (Code 2550)

Focuses on the sales channels for these products.

• Distributors (255010): Wholesalers of consumer goods.

  • Example: Genuine Parts, Pool Corporation, W.W. Grainger, etc.

• Broadline Retail (255030): Department stores and online marketplaces (such as Amazon) that sell mainly discretionary goods.

  • Example: Amazon, eBay, Target, Macy’s, Kohl’s, Alibaba, etc.

• Specialised Retail (255040): Stores focused on niches such as clothing, electronics, home improvement (hardware), computers, auto parts and furniture.

  • Example: Home Depot, Lowe’s, Best Buy, Gap, AutoZone, IKEA, etc.

Characteristics

• Unlike consumer staples, here companies depend more on promotion, presentation and price to attract the customer; the product does not sell itself by necessity.
• Cyclicality of sales is usually low or medium, although seasonality over the year is often pronounced.
• Business models are usually easy to understand, although many conglomerates in the sector have moved into activities away from the core, which can complicate analysis.
• Retail companies need to follow trends and preferences closely to stay relevant. In segments linked to fashion (e.g. apparel retail), a low multiple may reflect a business in decline; it is worth assessing the reason carefully before investing.

Key metrics

Like for like (LFL)

Like for like (LFL) measures real organic growth of retail companies, by excluding new openings and acquisitions from the comparable base. It shows average sales growth broken down by maturity and number of stores.

It is the key metric for valuing the sector: if a company has high LFL and the ability to keep opening stores, the effect on earnings can be very significant.

It is advisable to track LFL trends, as they are a good indicator of business health. Be very cautious when investing in retailers with declining or negative LFL.

Comparable sales are reflected directly in the valuation multiple: in the long term, higher LFL usually translate into higher multiples; if LFL weakens or turns negative, the market tends to cut the multiple noticeably.

Working capital

In retail it is common to find negative working capital: suppliers largely finance receivables and inventory. That can be very favourable when the business is doing well; if the business deteriorates, the company may be forced to inject cash to cover the working capital shortfall.

In models with negative WC it is essential to review this item in detail. Many of these companies maintain high cash positions as a buffer against a cycle reversal: in that context cash is not a bonus, but a necessity.

Be especially cautious with companies that combine negative working capital and debt. It is advisable to monitor the level and trend of working capital and its components (receivables/sales, inventory/sales, payables/sales) on a regular basis to avoid surprises.

Common valuation multiples

Typical multiples are usually in the range of:

• EV/EBITDA: 10–14x
• EV/EBIT: 12–16x
• P/E: 15–30x
• EV/FCF: 15–30x

The specific range will depend on LFL and potential business growth, the company’s moat, profit margins, ROIC and debt level.

TOP company example

• Amazon