Investing in ASX consumer discretionary shares

What are ASX consumer discretionary stocks?

The consumer discretionary sector is a subset of the retail industry. Retailers are businesses that sell products or services to end consumers. That is in contrast to wholesalers that sell goods to other companies, usually in large quantities. Retailers often purchase goods from wholesalers or suppliers and then resell those items directly to the public for profit. 

Consumer discretionary items include luxury and high-end products and services like designer brand handbags, electronic devices, and even holidays. 

In contrast, consumer staples are basic essentials like everyday food items and healthcare products. We like to splurge on consumer discretionary products when we have extra disposable income, whereas consumer staples are the bare necessities we usually can't get by without.

Retailers don't even need a brick-and-mortar presence anymore, with the COVID-19 pandemic only accelerating the trend towards e-commerce. Many retailers listed on the ASX now exist almost entirely online, such as furniture store Temple & Webster Group Ltd (ASX: TPW) and everything store Kogan.com Ltd (ASX: KGN). 

These companies sell products directly to customers via their website, often at discounted prices due to the money saved on overheads like rent.

Why invest in ASX consumer discretionary shares?

Retail is a fundamental part of a well-functioning economy. It facilitates the transfer of goods from the companies producing them to the consumers who get value from consuming those goods.

And, because consumer discretionary mainly comprises high-end brands, these companies tend to have very high profit margins. This means they perform particularly well when the economy is booming, and consumer confidence is high. So, having some consumer discretionary stocks in your portfolio can magnify your gains in a bull market.

Top consumer discretionary stocks on the ASX

There are currently about 134 companies listed on the ASX that fall under the consumer discretionary label. They include consumer services businesses like gambling companies, travel agents, hotels, car companies, homewares and apparel companies, and high-end retailers.

Here are three top consumer discretionary shares based on market capitalisation from high to low.

Wesfarmers

Wesfarmers owns many popular Australian retail brands that sell consumer discretionary items, including Bunnings, Kmart, and Officeworks. However, Wesfarmers is a large conglomerate of businesses. Apart from retail, it also operates in the chemical, energy, and fertiliser industries, among others. 

This makes Wesfarmers a good investment option for someone seeking exposure to several different sectors – not just retail – in a single trade. 

Aristocrat Leisure

Aristocrat Leisure is a gambling company that manufactures slot and poker machines. From relatively humble beginnings in suburban Sydney, Aristocrat has grown into a truly global company with a presence in Europe, the United States, Asia, and the Middle East. 

In recent years it has also branched out into digital and online gaming, making several major strategic acquisitions in the past decade. In 2017, it acquired Plarium Global and Big Fish Games, both of which design free-to-play online games.

Gambling companies fall under consumer discretionary because their products are things that consumers can spend their extra disposable income on but aren't staple items. Whether you want to invest in companies like Aristocrat might come down to your opinion of the ethics of the gambling industry.

JB Hi-Fi

One of Australia's most recognisable retail brands, JB Hi-Fi has a significant brick-and-mortar and online presence. The company sells high-end electronics like TVs, stereo equipment, computers, and other home appliances and consumer discretionary items. 

Despite challenging macroeconomic conditions caused by high inflation and rising interest rates, JB Hi-Fi delivered strong results for the year ended 30 June 2022. Sales rose 3.5% to an eye-watering $9.23 billion, driven by a 53% increase in online sales.

JB Hi-Fi has also started FY23 with a bang. The company reported double-digit sales growth across all its major divisions for the quarter that ended 30 September 2022. This likely shows how indispensable electronic devices have become in our daily lives. 

Pros of investing in consumer discretionary shares

As we've discussed, investing in ASX consumer discretionary stocks has plenty of pros. Retail is one of the bedrock industries of a well-functioning economy, and consumer discretionary includes a wide array of companies with different specialisations. 

Everything from high-end homewares stores to electronics outlets to travel agents falls under the banner of consumer discretionary, meaning you can gain exposure to various industries and consumer trends by investing in these stocks.

And the cons?

The main risk associated with investing in consumer discretionary stocks is that they tend to be cyclical in nature. The value of cyclical shares tends to rise and fall with the economic cycle — meaning they typically outperform the market in good times but underperform in bad times.

When the economy is booming, and households have plenty of extra income to splurge on designer handbags and flatscreen TVs, the profits of these companies will increase, driving up their stock prices. 

However, when money is tight, these products are likely to be the first things households cut back on, meaning the share prices of consumer discretionary companies can plunge in a recession.

Not only that, but consumer discretionary is a notoriously competitive sector. Given the popularity of e-commerce and online shopping, it's now cheaper than ever for new retail companies to enter the consumer discretionary sector and threaten the dominance of major brands. 

Digital retail companies like Temple & Webster, Kogan, and City Chic Collective Ltd (ASX: CCX) are threatening traditional retailers like Myer Holdings Ltd (ASX: MYR) that operate an extensive brick-and-mortar network.

This transition to e-commerce accelerated during the pandemic when many consumers switched to online shopping. Extended city-wide lockdowns also forced traditional retailers to close many of their stores – making maintaining a physical retail presence an expensive burden on many companies' bottom lines.

Finally, the fortunes of many retail companies are left up to the whims of consumer behaviour. People's tastes can be fickle, and consumer discretionary products frequently go in and out of fashion, become obsolete, or are replaced by better substitutes. 

This means some retailers that were previously successful can disappear overnight. Famous global brands like Blockbuster Video and Borders Books were forced into bankruptcy when new technology – namely video streaming services and ebooks – made their business models untenable.  

What to look for when buying shares

During the pandemic, lockdowns and social restrictions accelerated the mass adoption of e-commerce platforms. Retailers with a robust digital presence grew their revenues rapidly and, in many cases, stole market share away from more established competitors with a significant brick-and-mortar presence. This has fundamentally changed the makeup of the industry.

But with inflation running hot and interest rates on the rise (not to mention ongoing supply chain issues), near-term conditions will be particularly challenging for this new generation of online retailers. This means that new investors need to do plenty of research before investing in consumer discretionary shares. 

The industry is dotted with potential minefields. For example, shares in digital companies that were pandemic market darlings (like City Chic and Temple & Webster) have plunged over the past year, with investors worried that macroeconomic headwinds would significantly dampen growth. 

In other words, investing in consumer discretionary isn't for the faint of heart. If you are seeking exposure to these industries, look for companies with a proven track record, low costs, and a healthy balance sheet, as not all companies will survive in these economic conditions. And be prepared to weather some short-term pain.

Are ASX consumer discretionary stocks right for you?

Consumer discretionary shares are cyclical. This makes them great to own when the economy is booming, and people have plenty of extra money to splurge on shopping. But when money is tight, these companies' profits  – and share prices – tend to fall.

That doesn't mean investors should exclude consumer discretionary shares as part of a well-diversified portfolio. Retail – and consumer discretionary, in particular – is one of the most fundamental industries in any thriving economy. These are the products we choose to splurge on that give us the greatest pleasure in life.

However, before investing in any ASX consumer discretionary shares, ensure you understand the risks involved and be prepared to absorb some losses if the economy hits a few bumps in the near term.