Investing 101

Your Go-To Guide for Investing in Consumer Stocks & ETFs

by Q.ai Team

Apple.

Coca-Cola.

General Mills.

Chegg.

What do these four securities have in common – other than being large, well-known corporations? Answer: They’re all examples of consumer stocks.

Consumers stocks are issued by businesses that produce or sell products that the everyday person purchases regularly. There are two categories of consumer stock, both with their own challenges, benefits, and pricing cycles.

In this article, we’ll discuss:

  • The similarities and differences between both types of consumer stocks
  • Some of the biggest names in consumer securities
  • Typical investment approaches for both types of stock

TL;DR

  • Consumer stocks are offered by companies that produce or sell everyday goods. There are two types. Staple stocks sell items that consumers can’t (or won’t) forgo in their budget (such as groceries and personal care items). And discretionary stocks sell items that aren’t necessary (such as entertainment, cars, and fast food).
  • Consumer staple stocks are typically impervious to business cycles due to consistent demand. As such, they generate consistent returns even in sluggish economies.
  • Consumer discretionary stocks underperform the market in slow economies and lead the bull charge in growing economies, leading to increased volatility and potential for profitability.
  • Typically, investors use consumer staple stocks as part of a defensive investment strategy in downturned markets, or to diversify their portfolios. By contrast, discretionary stocks can be part of short- or long-term strategies to boost earnings.

What is a Consumer Stock?

When we say, “consumer stocks,” we’re talking, broadly, about the goods that you need or want on a regular basis. We can divide this group into two types: consumer staples and consumer discretionary goods.

Consumer staples are the items you can’t (or won’t) live without, regardless of your financial situation. Common examples include groceries, alcohol and tobacco, personal care items, and household necessities. Companies that work in the farming and pharmaceutical industries also fall under this umbrella.

Consumer discretionary goods are the items that are quasi-essential but not absolutely necessary. These include items such as computers, entertainment, cars, and fast food. Some industries that produce goods required for modern living, but not for life, also belong in the discretionary category. (Clothing manufacturers are one such example.)

Why Invest in Consumer Stocks?

Consumer stocks of both stripes can provide unique benefits to an investors’ portfolio. This is, in part, because of when they peak in the broader economic cycle.

As a rule, consumer staples are non-cyclical, which means they’re always in demand. Because most people can’t (or won’t) cut these items from their budgets, staple industries are nigh on impervious to price elasticity and broader business cycles.

This means that, during periods of recession or sluggish growth, consumer staple spending may slow. But it won’t grind to a halt. In fact, some periods of recession have seen consumer staple stocks leapfrog ahead of more exciting industries.

Consumer discretionary stocks, on the other hand, are cyclical securities, which means they respond to economic cycles. As a rule, consumers worried about their finances spend less on frivolity, while consumers secure in their financial situations are more likely to splurge.

Thus, in periods of economic downturn, consumer discretionary spending often spearheads the broader market decline. This leads to car companies, clothing conglomerates, and the entertainment industry slowing, or even experiencing negative growth. But when the market expands again, discretionary stocks lead the charge into recovery.

Consumer Stocks in 2020: An Unusual Year

It’s prudent to note that some of what we long considered “discretionary” is essential to participating in modern society – especially post-pandemic. It’s true that discretionary stocks typically tank during economic contractions. But many consumer expenditures became necessary during the pandemic in a way they never were before.

Perhaps the most poignant example is the technology industry. Components like broadband connection are required to stay in touch while social distancing. And it’s effectively impossible to work or learn remotely without them. And without Netflix and Disney+, who knows how many bored children would have run screaming in the streets?

As a result, when you look at 2020 consumer spending, the research paints a markedly different picture than recessions past:

Consumer Stocks Compared to the S&P 500: May 2020 – Present Image Credit: Fidelity

As you can see, in the last 12 months alone, consumer discretionary stocks – the sector that’s supposed to slow during a recession – beat both the S&P 500 and consumer staples by an enormous margin.

By contrast, consumer staples spending underperformed both the broader market and the S&P 500. This highlights further the modern distinction between “discretionary” and “staple.” (As well as the fact that half the globe suddenly leapt online for work, play, and everything in between in just a few months.)

The change is even starker when you look at the last three years:

Consumer Stocks Compared to the S&P 500: July 2018 – Present Image Credit: Fidelity

Here, we see that consumer discretionary stocks met or barely outperformed staple stocks within a much smaller margin between 2018 and early 2020. As soon as the pandemic hit, the market tanked – and then discretionary securities skyrocketed well above both the S&P 500 and staple stocks.

Sure, the past performance is not a guarantee of future gains (or losses). But it’s worth noting that it’s unlikely this newly minted trend will reverse anytime soon. The world is increasingly relying on technology.

Big Names in Consumer Securities

When it comes to big names in consumer securities, we’ve already listed a few – Apple, Coca-Cola, and General Mills among them. And while Chegg isn’t an enormous company, we thought it worth including due to the massive shift in online learning over the last year.

Big Names in Consumer Stocks

Now, let’s take a closer look at some of the biggest names in consumer investments (and their 2020 performance):

  • Apple, Inc. is a behemoth among consumer discretionary stocks with a market cap of $2.22 trillion. The stock started 2020 at $74 a share before plummeting to just under $56 per in mid-March – and ended the year on a $135 high.
  • Coca-Cola Co commands a health $229 billion market cap in the consumer staple market. The beverage corporation began 2020 at $55 and ended at $54 after hitting a $36 low in the interim.
  • Chegg, Inc. is an up-and-coming discretionary stock with a sizeable market cap of $12.5 billion. It began 2020 at a piddly $38 – and doubled to $89 and change in eight months, more than bouncing back from its $26 mid-March low.
  • General Mills, Inc. is worth just under $37 billion in shares, despite coming out just $6 up between January and December 2020 (from $53 to $59). Still, it outperformed Coca-Cola!
  • Procter & Gamble Co owns dozens of brands, including Crest, Gillette, and Dawn, and is worth nearly $334 billion as a consumer staple stock. PG started 2020 at a healthy $124.50 per share and ended just under $139 – after rebounding from a March low of $94.
  • Best Buy Co., Inc. is one of 2020’s success stories. As a brick-and-mortar electronics retailer, they saw their market cap grow to $30 billion, with shares jumping from $88 to over $101 in the midst of a pandemic, over double their March low of $48.

Big Names in Consumer ETFs

While we’re naming the big fish, let’s quickly cover some of the biggest consumer ETFs, as well.

The Consumer Staples Select Sector SPDR ETF (XLP) tracks the Consumer Staples Select Sector Index. As a result, it offers broad exposure to the consumer staples sector, and is the largest consumer staples ETF with over $10.8 million in total assets. XLP has significantly underperformed the S&P 500 Index for the majority of the last five years:

XLP 5-year Performance Compared to S&P 500 Index Image Credit: CNBC

The Vanguard Consumer Staples ETF (VDC) tracks the MSCI US Investable Market Consumer Staples 25/50 Index. It offers targeted exposure to over 100 stocks in the U.S. consumer staples sector and manages $5.5 million in total assets. This ETF fared slightly better than XLP over the last half-decade by a small margin:

VDC 5-year Performance Compared to S&P 500 Index Image Credit: CNBC

The Consumer Discretionary Select Sector SPDR Fund (XLY) tracks the Consumer Discretionary Select Sector Index. This ETF offers broad exposure to the consumer discretionary sector and manages $20.4 million in total assets. XLY managed to outperform the S&P 500 Index by a not-insignificant margin over the pandemic, after walking in lockstep for much of the previous five years:

XLY 5-year Performance Compared to S&P 500 Index Image Credit: CNBC

The Vanguard Consumer Discretionary ETF (VCR) manages $5.9 million in total assets. This ETF tracks the MSCI US Investable Market Consumer Discretionary 25/50 Index and thereby offers targeted exposure to U.S. consumer discretionary sector. Although VCR closely tracked the S&P 500 Index for much of the late 2010s, it overshot the Index in the latter half of 2020:

VCR 5-year Performance Compared to S&P 500 Index Image Credit: CNBC

Considerations when Investing in Consumer Securities

For those investors looking to dabble in consumer securities, it’s important to note that each sector comes with its challenges and benefits.

On one hand, we have consumer staples. As these are buoyed by consistent demand, they in turn generate consistent revenues, are more impervious to recessive declines, and may experience above-market performance in some economic downturns. Additionally, consumer staples often offer high dividend yields and (for some) consistent payout increases.

However, staple stocks are also typically slow growing, even in the best of economies. They also have limited price highs and may underperform the market when interest rates rise.

On the other hand, we have consumer discretionary stocks. These cyclical investments may outperform the broader market in a robust economy but experience a fair amount of spring back during periods of recession. (Unless, it seems, in case of a worldwide pandemic shifting the status quo to a work-from-home arrangement.)

As a result, they’re more volatile than staple stocks, and can experience both exorbitant highs and catastrophic lows in short periods of time.

Investing Approaches

In a growing economy, most sectors will see some level of stock value increases, aided along by increased profits and consumer income. As consumer discretionary securities often lead a stock market recovery, hopping on early and holding long-term – or until the market begins to fall – is a popular (and potentially profitable) strategy.

By contrast, consumer staples are common fare during recessions as part of a defensive investment strategy. As a rule, consumer staples stocks are best for investors who want steady growth, consistent dividends, and moderate to low volatility.

Moreover, because staple stocks perform counter to consumer discretionary stocks during recessions, they provide a safe haven for diversified investors to boost gains in the face of impending – or past – losses.

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