How to analyze the market? Consumer Services

Consumer Services

We generally don’t find a ton of great long-term stock ideas in retail and consumer services because most economic moats for the sector are extremely narrow, if they exist at all. The only way a retailer can earn a wide economic moat is by doing something that keeps consumers shopping at its stores rather than at competitors’. It can do this by offering unique products or low prices. The former method is tough to do on a large scale because unique products rarely remain unique forever. It’s rare to find a retailer or consumer service firm that maintains any kind of economic moat for more than a few years.

The few consumer service firms that have established a wide economic moat:
Home Depot and Lowe’s in the home improvement area
Walgreen’s for prescription drugs and convenience items
Wal-Mart for just about everything.

These firms developed distinctive store prototypes that set them apart from their competitors and they now enjoy vast economies of scale that make it rough for competitors to earn consistent profits. Identifying and investing in firms like these (at the right price) is the best way to make money over the long haul in this classic “buy what you know” area of the market. Although you can also do well buying high-quality specialty and clothing retailers when the industry sees one of its periodic sell-offs, very few of these kinds of firms make great long-term holdings.

Companies we see everyday.
Most of the companies in the consumer services sector are very familiar: We shop at their stores and eat their food just about every day. The sector contains discount stores such as Wal-Mart and Target, drugstores such as Walgreen and CCVS, clothing stores such as Gap, home improvement shops such as Home Depot and Lowe’s, restaurants such as McDonald’s and Outback Steakhouse, and scores of other well-known names. Being able to peruse the aisles of these stores, interact with employees, and sample products is a huge advantage from an investment standpoint.

The consumer services sector has seen strong growth too. Our time-starved culture, with both parents working full time in more families, demands quick and reliable service and is willing to pay for it. Grocery stores offer more ready-to-eat or quick-to-prepare meals, discount stores now almost exclusively have centralized checkouts at the front of stores, and many drugstores stay open 24 hours a day. Companies that provide the best overall service at a competitive price survive and thrive, while those that don’t fade and eventually disappear.

According to the U.S. Census Bureau, the U.S. economy increased from $6 trillion in 1991 to $10.1 trillion in 2001. During that time, consumer spending increased from 66 percent to 69 percent of the economy. Consumer service firms are becoming a bigger piece of the economy, and we expect that trend to continue. It’s not surprising that these companies have outperformed the overall market over the past decade.

Consumer staples versus consumer discretionaries.
Because many consumer purchases other than food (consumer staples) are discretionary (can be put off for later), it’s not surprising that retail stocks generally outperform during periods of economic strength and underperform during times of economic weakness.