Consumer discretionary stocks don’t usually do well during recessions. Economists think we are going to experience a shallow recession in the first half of 2023. This could mean a potential buying opportunity in consumer discretionary stocks that appear to trade at decent valuations. Stocks are forward looking and often move ahead of results, which means stock sales could be gone before you know it.
Here are a couple of consumer discretionary stocks I’m watching this month.
Canadian retail stock
Canadian Tire (TSX:CTC.A) is an iconic Canadian retailer that I’ll be keeping watch. The market thought the consumer discretionary stock was too cheap to ignore, as it bid up the stock by approximately 16% year to date.
The stock sold off in 2022 as investors feared the company would do poorly due to higher inflation because it sold consumer discretionary products like durable goods and sporting goods. Indeed, at $163 and change per share, the Canadian retail stock trades at about 9.7 times earnings, which is a discount of about 24% from its long-term normal valuation of 12.8 times earnings.
It could take until the red alert for the recession is off before the stock could trade at that multiple. Let’s be super conservative and say it takes five years to get there; the dividend stock could deliver annualized returns of approximately 16%. This includes the contribution of its current dividend yield of 4.2%.
The dividend stock’s payout ratio is sustainable at about 40% of earnings. Notably, it has increased its dividend for about 12 years with a three-year dividend-growth rate of 12.1%.
Magna International stock
When it comes to consumer discretionary stocks, Magna International (TSX:MG) stock is even more cyclical than Canadian Tire. For instance, the auto parts maker saw its adjusted earnings per share falling 35% during the 2020 pandemic year.
However, it also rebounded swiftly the following year with 30% growth. In the past decade, Canadian Tire stock’s best and worst years saw returns of 46% and -19%, respectively. Magna stock’s were 79% and -24%, respectively.
In other words, in an economic expansion, which is bound to come eventually some time after a recession occurs, Magna stock can result in substantial gains. Simultaneously, it could be more difficult for investors to hold on due to its higher volatility and unpredictability.
That said, Magna is a larger and more resilient business than it was 10 years ago. It also maintains a low payout ratio to keep its dividend safe. Its payout ratio is estimated to be about 32% of earnings this year. So far, it has increased its dividend for about 13 years with a three-year dividend-growth rate of 7.2%.
At $87 and change per share, it yields about 2.8%. Analysts generally believe it’s fairly valued.
Because stocks are forward looking, it could be difficult for investors to time their investments in consumer discretionary stocks. Perhaps it would be smart to investigate businesses that have delivered strong returns in the long run. Otherwise, investors can keep watch on solid consumer discretionary stocks like Canadian Tire and Magna International, aim to buy them during recessions, and hold through a subsequent economic expansion phase for the potential of materializing substantial gains.