Consumer Stocks: Who's Poised to Profit?

Investors are looking for companies that can prosper even as Americans try to shop less and save more

By Ben Steverman

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It's a scary time to be investing in consumer stocks.

Americans, heavily in debt, are losing jobs at a rapid pace, while their main sources of wealth, such as stocks and real estate, have plunged in value.

Consumers are saving more and cutting spending, and that's unquestionably bad for consumer-focused industries on the whole. However, investing experts say, some companies are finding ways to exploit and prosper from consumer belt-tightening.

When stressed, consumers don't cut back on all purchases equally, notes Cindy Axelrod, an analyst at investment manager Glenmede. "U.S. consumers are not only spending less," she says. "They're spending smarter. They're looking for better value."

Cheap Isn't Everything

Many consumers are trading down from pricier goods to lower-priced products. In the most recent quarter, revenues at Wal-Mart (WMT) slipped 0.07% from the year before, while sales at pricey department store Saks (SKS) dropped 27%. (Meanwhile, Wal-Mart shares fell 15% in the past 12 months, while Saks' stock plunged 67%.)

But customers don't buy on price alone. Chains like Kohl's (KSS) try to beat low-cost Wal-Mart not on price but by offering more fashionable clothes, notes Robert W. Baird analyst Erika Maschmeyer.

"There is a trend—helped by the recession—toward buying fewer discretionary items, but focusing on more meaningful items," Maschmeyer says. "Going forward, consumers are going to be more picky."

There are some products that consumers will stop buying only as a last resort. That's why Wall Street splits consumer stocks into "staples" and "discretionary" categories. Thus, several fund managers say they are investing in traditional consumer staples like food companies or supermarket chains. "We still like to eat," says Walter Gerasimowicz of Meditron Asset Management, who owns shares of Ralcorp Holdings (RAH), a maker of cereal and other food products.

But there are also consumer purchases that, while technically discretionary, rarely get cut in practice.

Bull Path Long Short Fund (BPFIX) portfolio manager Rob Kaimowitz owns shares of DirectTV (DTV). Even though the satellite TV's offerings are often more expensive than those of competitors, people are unwilling to scrimp on television. "If you can afford to keep the lights on, you're going to be watching TV," Kaimowitz says of most Americans.

Generics and Mail-Order

Another investing theme for frugal times is companies that actually help consumers save money.

Glenmede's Axelrod argues Express Scripts (ESRX) falls in this category. A pharmacy benefit manager, Express Scripts works on directing its customers to less expensive generic drugs. It also encourages consumers to order prescriptions through the mail, "another way for the consumer to get a better bang for their buck," she says. (Glenmede owns shares.)

For investors, a key question is how long consumer belt-tightening lasts. If the economy returns to positive growth, will shoppers again mob high-end department stores and start running up their credit-card bills?

That's unlikely, says Kent Croft, a manager of the Croft Value Fund (CLVFX). "The consumer recovery is probably going to take a while," he says, "rather than something that bounces back quickly and people go right back to Nordstrom (JWN)."

With the unemployment rate moving ever closer to 10%, consumers are likely to be cash-starved for a good while. But even if Americans have money to spend, they're unlikely to go on the debt-fueled spending sprees of years past, says Jim Reed, portfolio manager of the UMB Scout Stock Fund (UMBSX). New regulations and economic realities mean big changes for the credit-card business, Reed notes. "Fewer people will get credit, and the terms are going to be tougher," he says. "The bottom line is a systemic and long-term reduction in the availability of credit to consumers."

Long-term, there could be positive consequences in the U.S. from more savings and less spending and debt. But in the meantime, the result is more pain for most consumer-focused companies.

Thus, investors are left with the difficult task of finding the exceptions to this trend and buying their shares at fair prices.

See the accompanying slide show for 16 recommendations from top investing experts.

Steverman is a reporter for BusinessWeek's Investing channel.

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