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What are we looking for?

In the second quarter, fiscal and monetary interventions were massive and to some extent, stronger than the shock from COVID-19. As a result of these interventions, U.S. consumers’ disposable income is 6 per cent higher than it was in January, leaving them with more money than before the crisis. The economy appears to be recovering quickly with U.S. retail sales growing at 1.1 per cent year-over-year favouring cyclical stocks. We will look at U.S. large caps operating in the consumer discretionary sector. These are serious candidates where consumers could spend their extra cash.

The screen

We screened U.S. companies focusing on the following criteria:

  • Market capitalization higher than US$15-billion;
  • Performance Score of more than 75 from analyst StockPointer (SP) – the score mainly considers risk-adjusted return on capital and free cash flow per share. The score varies between zero and 100;
  • Return on capital (five-year mean) higher than 12 per cent – we look for a firm with a considerable return on capital. Consumer discretionary stocks have profited from the last economic boom so we can set a high return on capital;
  • Positive three-month change in sales – we want a business whose sales have not been hit too hard by COVID-19;
  • Positive one-year dividend growth – we look for a company that continued to increase its dividend. For informational purposes, we have also included recent, stock price, dividend yield, one-year price return, net operating profit (NOP) change over 24 months, return on capital and earnings per share growth (five-year-mean);

More about Inovestor

Inovestor for Advisors is a fundamental-analysis research platform specializing in the economic value-added (EVA) approach.

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What we found

Home-improvement retailer Home Depot Inc. has an impressive performance score of 90. The five-year return on capital is also incredible at 30 per cent. In the long run, we expect the Atlanta-based company will manage to increase its sales around the GDP growth level while adding a small amount of capital. The increase in free cash flow will allow a dividend increase. The various restrictions related to the pandemic may have pushed consumers to renovate their houses during their spare time. The company reports their second-quarter results on Aug. 18 before market opening.

U.S.-based auto parts and equipment retailer O’Reilly Automotive Inc. has a robust return on capital of 26.7 per cent. Its short-term sales grew by 4.9 per cent despite the pandemic during the second quarter, showing strong execution by management in face of consumer demand. Individuals may have used their cars more for vacations as other options were limited. The company generated an impressive annual earnings-per-share growth of almost 20 per cent in the past five-year period. The company doesn’t pay a dividend, but it returned $1.1-billion to shareholders through buybacks.

Farm supply and home improvement retailer Tractor Supply Co., also based in the U.S., has a trailing 12-month return on capital of 23.1 per cent, which compares positively with its five-year mean of 18.2 per cent. It increased sales by 9.7 per cent in the past three months and realized an NOP growth of 43.4 per cent over 24 months showing great momentum both in the short and medium term. The dividend growth is lower than other firms figuring on the list, but the company chose to strengthen its balance sheet by adding $1.1-billion in cash and cash equivalents compared with the previous second quarter: An understandable decision considering the circumstances.

Seven U.S. consumer discretionary stocks with sizeable long-term return on capital

NAMETICKERPRICE ($ USD)MKT CAP ($MIL. USD)SP PERF. SCORERTN ON CAPITAL 5Y-MEAN (%)SALES CH. 3M (%)1Y DIV. GROWTH (%)NOP CH. 24MEPS GROWTH 5Y-MEANRTN ON CAPITAL (%)DIV. YIELD (%)1Y PRICE RTN. (%)
Home Depot, Inc.HD-N271.6429216090.030.41.725.420.315.335.52.229.4
O'Reilly Automotive, Inc.ORLY-Q465.183447077.726.74.90.024.519.929.20.021.9
Autozone, Inc.AZO-N1182.222762076.526.40.00.07.613.028.80.08.6
Tractor Supply Co.TSCO-Q148.11712088.518.29.79.443.414.923.21.135.8
Lowe's Companies Inc.LOW-N152.7811535088.016.22.714.623.116.220.41.452.1
Costco Wholesale Corp.COST-Q340.9115052082.713.11.612.330.19.914.20.824.1
Dollar General Corp.DG-N195.294916084.113.06.610.922.616.514.00.742.1

Source: Inovestor

Christian Godin is a portfolio manager at Inovestor Asset Management.

For more details about these Consumer Discretionary, please subscribe the Inovestor for Advisors platform for free: https://www.inovestor.com/en-CA/store/

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