Picking Through the Consumer Stock Bin

S&P analyst Thomas Graves talks about some picks and pans in the economically sensitive consumer-discretionary sector

With consumers still spending, Standard & Poor's continues to list the consumer-discretionary sector as on area to overweight, according to Thomas Graves, group head of the S&P analysts covering this investing area. (S&P defines consumer-discretionary companies as those whose products shoppers can defer purchasing if they feel pinched.) The stocks S&P favors cover a broad range of industries, including travel, gaming, and electronics.

Graves made these points in an investing chat presented Sept. 30 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from Jack Dierdorff of BW Online. Edited excerpts from this chat follow. A full transcript is available from BW Online on AOL at keyword: BW Talk.

Thomas Graves is an S&P equity analyst. He has no affiliation with or ownership interest in any companies under discussion. Other S&P affiliates may provide services to the companies under discussion. He is a registered representative of Standard & Poor's Securities Inc.

Q: How have consumer stocks been holding up?


We continue to recommend overweighting consumer-discretionary stocks. This sector represents about 11% of the market capitalization of the S&P 500. Year-to-date, the consumer-discretionary sector has outperformed the S&P 1500 index through Sept. 26. Our sector index is up 20.2%, while the S&P 1500 is up 13.9%.

Q: Where does S&P draw the line between discretionary and staples in the consumer area?


We regard staples as being types of industries or companies in which consumers make day-to-day purchases on which they feel little choice. This includes categories such as food and beverages. In comparison, we view the consumer-discretionary area as being one in which consumers are more able to defer purchases if times are tough and are more likely to release their purse strings when economic times improve. Thus, we see consumer- discretionary stocks as being more tied to expected changes in the overall economy.

Q: This gives you an early chance to tell us about some stocks rated buy in your sector: Top pick, please?


U.S. equity analysts at Standard & Poor's have recommendations on approximately 200 consumer-discretionary stocks. Of those, we have a buy opinion on about 16 stocks. Our favorites include InterActiveCorp. (IACI ), Regis Corp. (RGS ), and D.R. Horton (DHI ).

Q: Your outlook on the gaming sector -- Harrah's Entertainment (HET ), MGM Mirage (MGG ), and International Game Technology (IGT )? They're happy to take consumers' money!


Harrah's Entertainment is our favorite stock in the gaming area. We have a buy opinion on the shares and a 12-month target price of $50. MGM Mirage is another casino stock, and we have a hold opinion on it, while we also have a hold opinion on IGT.

Q: Were any of the buys in your sector recently added?


One of the recent additions to our 5-STARS (buy) list is La Quinta Corp. (LQI ), which is a hotel company with a relatively small market capitalization. This selection does represent a REIT (real estate investment trust) as opposed to just common shares. Another relatively recent addition to our 5-STARS list is Black & Decker (BDK ).

Q: Do you think consumers can keep spending like gangbusters?


We believe that the outlook for consumer spending is relatively good. Although unemployment is creating some concern on the part of consumers, we do feel that federal tax cuts should be stimulative for consumer spending. And we believe that there remain a significant number of attractive investment opportunities in the consumer-discretionary sector.

Q: How about retailers? Anything in department stores or apparel S&P likes?


In the apparel area, one of our favorite stocks is Quiksilver (ZQK ), while some other retail stocks that we like include Staples (SPLS ) and Best Buy (BBY ).

Q: Tom, what's your feeling about valuations? It appears that high valuations are a reason behind many of your hold recommendations.


Our feeling is that valuations are quite clearly anticipating an improving economy in the year ahead. In many cases, we feel that stock prices are adequately reflecting the economic expansion that we're expecting. However, we still see a good number of stocks in our sector that we expect will provide above-average appreciation.

Q: Can you list your sell and avoid stocks?


Some of the stocks on which we have a sell opinion include Goodyear Tire & Rubber (GT ), Starbucks (SBUX ), and Delphi (DPH ).

Q: I heard Sears (S ) was expanding to compete with Wal-Mart (WMT ) and Target (TGT ). What do you think of Sears? And Target, for that matter?


We have a hold opinion on shares of both Sears and Target. However, we are not recommending new purchases of either stock.

Q: Point of clarification: If accumulate means outperforming the S&P 500, what is the criterion for buy?


Basically, the difference between a buy opinion and an accumulate opinion is the extent to which we expect a stock to provide an above-average risk-adjusted total return over the next 12 months. Typically, we would be looking for a buy opinion to provide a higher risk-adjusted return than we would shares on which we have an accumulate opinion.

Q: And can you give us some accumulate stocks in your area you haven't mentioned yet?


Some stocks in the consumer-discretionary area on which we have an accumulate opinion include Carnival (CCL ), Bed Bath & Beyond (BBBY ), and Mandalay Resort Group (MBG ).

Edited by Jack Dierdorff

Before it's here, it's on the Bloomberg Terminal.