Consumer Discretionary and Consumer Staples are two important sectors in the stock market, as they represent different types of consumer products and services people buy, depending on the economic cycle and global growth prospects. Because high inflation and higher interest rates impact people’s spending behavior, it’s interesting to focus on these sectors to better understand their differences and their growth prospects to take advantage of the best trading and investment opportunities.
What do we mean by the consumer discretionary sector?
We call the consumer discretionary sector the market sector gathering companies selling products and services that are considered non-essential, which means that they will only be bought when consumers have enough disposable income to spend. If they don’t buy these items, then there are no major consequences on their health or well-being. Their decision is therefore “discretionary”, hence the name of the sector. The level of consumer confidence and purchasing power is essential for brands operating in the consumer discretionary sector, as they will dictate their spending habits.
If you’re looking for examples of consumer discretionary companies, you can have a look at the following industries:
- Apparel and textiles (Nike, Adidas, Gap, H&M)
- Non essential food services (Uber, McDonald’s, Starbucks, Chipotle Mexican Grill)
- Tourism (Marriott International, Delta Airlines, AirBnB, Expedia)
- Household furniture and appliances (Best Buy, Home Depot, Whirlpool)
- Leisure and entertainment (Netflix, Walt Disney Company)
- General retail (Target, Home Depot, Lowe’s Companies, Macy’s)
- Automobile and automobile components (Tesla, Continental, Faurecia)
What do we mean by the consumer staples sector?
We call the consumer staples sector the market sector composed of companies selling products and services that are considered essential for everyday life, such as food, drinks, and health-related products. These items usually have major consequences on consumers' health or well-being if they aren’t bought. Here, the level of consumer confidence and purchasing power is not an essential factor, as these items are considered non-discretionary - we spend around 70% of our income on them.
If you’re looking for examples of consumer staples companies, you can have a look at the following industries:
- Food and beverage (Nestle, Kraft Heinz, General Mills, Campbell Soup)
- Personal care products (Procter & Gamble, Unilever, Colgate-Palmolive)
- Pharmaceuticals (Pfizer, Johnson & Johnson, Novartis, Sanofi)
What are the pros and cons of investing in consumer discretionary shares?
In addition to being great for diversifying your portfolio with cyclical stocks, investing in the consumer discretionary sector in times of economic expansion or rebound is a great way to take advantage of the extra money consumers have and want to spend on non-essential items.
The discretionary sector is also a very diversified one, which means that there are many companies and sub-sectors to invest in.
It is also often thought that some of the most well-known brands have strong brand power and a solid competitive advantage. Very often, these companies rely on innovation to thrive, which means that they will often launch new products and services to attract customers, which might provide strong returns for investors. Consumer discretionary companies are also better equipped to capitalize on changes in consumer trends and preferences.
On the other hand, consumer discretionary companies are very sensitive to the economic cycle and suffer when the economy is shrinking or in times of recession. They are also affected by higher inflation as buyers might decide to postpone their purchases or turn to brands that offer cheaper options.
As we’ve just seen, consumer discretionary companies usually sell very price-sensitive products and services, which are items that consumers tend to purchase based on price rather than on other factors such as brand loyalty. In that case, it will be important to take into account factors such as pricing strategies, cost controls, and market share before picking such a company to invest in.
Consumer discretionary companies also often deal with disruptions to the supply chain, especially over the last few years, which can impact their reputation, cause shortages, increase their production costs and reduce their margin. This is especially true for companies relying heavily on imported goods and commodities.
What are the pros and cons of investing in consumer staples shares?
The biggest advantage of investing in consumer staples companies is profiting from steady demand, as the products and services sold aren’t that sensitive to the economic cycle, as they’re bought regardless of economic conditions. Therefore, they are considered a great way to profit from companies relying on reliable sources of revenues. Consumer staples companies indeed tend to have stable revenues as demand for their products is not subject to wild fluctuations due to changes in the economic cycle.
Therefore, these types of companies are considered less risky and less volatile than consumer discretionary shares, which will please risk-averse investors.
Many consumer staples companies distribute dividends to reward the loyalty and financial support of shareholders. Because of consistent cash flows, a number of these firms have a history of increasing their dividends payments over the years, which means that they are great options for those looking for increasing passive revenue.
On the other hand, consumer staples shares will usually not profit from impressive growth as consumer discretionary stocks might, as the demand for non-discretionary products and services is relatively steady. The upside potential is therefore limited, especially over the short-term. These types of stocks are more suitable for long term investors.
When should you invest in consumer discretionary shares?
Because consumer discretionary shares are considered cyclical stocks, they are very sensitive to the economic cycle. The demand for consumer discretionary products and services will therefore tend to increase during economic expansion phases, as consumers have more disposable income to spend.
You should therefore closely monitor the evolution of the economic cycle we’re in and what the growth and inflation projections are to determine if consumers will globally increase or decrease their spending. For that, you can follow the economic calendar to see when major economic statistics are being published, such as reports on consumer confidence and spending, inflation, employment, and growth.
When should you invest in consumer staples shares?
As consumer staples companies are almost not subject to economic conditions, they are considered defensive stocks to invest in whenever you’d like. Of course, they will tend to under-perform compared to consumer discretionary shares in times of economic expansion, but they will also perform better in times of rougher economic conditions.
To make the most informed decision about when to invest in consumer staples, you should first consider the sub-sector you want to invest in to determine what the key challenges the company needs to overcome are, and what growth opportunities it can benefit from.
What are the best ways to invest in the consumer discretionary and staples sectors?
If you’re interested in the consumer discretionary and stables sectors, there are 3 major ways to invest in these sectors :
- Invest in individual stocks
- Invest in dedicated indices such as the S&P 500 Consumer Discretionary Index or the S&P 500 Consumer Staples Index, for instance
- Invest in consumer staple or consumer discretionary equities ETFs (Exchange-Traded Funds), which gives you a chance to have a basket of shares of either the consumer staples or discretionary sectors but from different geographical areas
Regardless of the method you use, remember to always take into account your risk tolerance, your strategy, your investment or trading horizon, as well as your financial goals. It will help you decide the best way to get an exposure to these market sectors.
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