The Consumer Discretionary Sector -- Only Invest in the Best

Joseph is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When investing in the consumer discretionary sector, it's wise to consider the future implications and strengths of a company’s business. Personally, if I'm going to invest in the discretionary sector, only the best of the best attract even the slightest attention for my portfolio. Strong businesses with strong brands and strong products are a bare minimum. Two companies that I'm currently bullish on in this sector are Nike (NYSE: NKE) and Walt Disney (NYSE: DIS).

Iconic, globally recognizable brands coupled with strong product portfolios

Everyone knows the Nike Swoosh and Mickey Mouse. Nike dominates footwear and sporting apparel. The company has shoes originally designed in the 1980's that still sell like hotcakes, shoe models such as the Dunks or Air Force 1's, which can be re-released over and over in different color ways. The company also owns the iconic Jordan brand.

Air Jordan shoes are not only popular, but are also highly collectible. Nike and Jordan sneakers enjoy almost a cult following of collectors. The company could likely never produce another style of shoe and still sell thousands of sneakers-- simply by relying on its previous sneaker models, which have been integrated into American and even global, pop-cultures. Along with legends like Michael Jordan, the company also has a strong sponsorship portfolio of active athletes from a multitude of different sports-- from the PGA's Tiger Woods to the NBA's LeBron James. 

Like Nike, Disney also has a strong portfolio of past successes that it can rely on in the present. Disney's Mickey Mouse and other characters are so ingrained in our culture that they are almost eternally etched into the minds of American society.

Cartoons such as Fantasia, Lion King -- pretty much any popular children's movie-- usually belongs to Disney. The company can re-release these titles from its catalog and still rake in the dough, not to mention all of the merchandise and toys that spring from these movies and characters as well. 

Nike and Disney both sit on rock-solid foundations that are built on past successes.

But what about the future?

Disney's future prospects look bright as well. The company’s most recently released film, "Oz the Great and Powerful," generated over $80 million for Disney and enjoyed the largest domestic debut of the year. Looks like another success to add to the company's catalog. Disney has also greatly expanded its catalog by inheriting the Star Wars franchise as well, after purchasing it from Lucasfilm. 

Merchandise related to the Star Wars franchise is already coming, as well as plans for more films. It's even rumored that individual Star Wars characters will get their own "spin-off" movies. If the past is any indication, Disney will likely take the Star Wars franchise to a whole new level, which should also increase the brand's overall value to shareholders, as well. 

Nike also has bright future prospects. The company recently reported a 55% leap in fiscal third-quarter earnings. An unexpected increase in North America offset slower growth in China. Shares on Nike immediately popped over 7% after the announcement. The company also reported increasing revenue and gross margins. Nike has been on a tear, so will it continue? Goldman Sachs thinks so. After initiating coverage on Nike, Goldman stated that:

We resume coverage of Nike with a buy rating and 20% upside to our $70, six-month price target. After an extended period of sub-par EPS, Nike appears to be on the verge of a multi-year growth spurt, with visibility into critical P&L drivers: high-single-digit top-line growth balanced by developed and emerging markets, margin expansion towards multi-year highs, and significant opportunity to flex the balance sheet on buybacks and dividends. We expect 18%-to-20% EPS growth, and this coupled with improved understanding of Nike's quality business model should support valuation in the low-20X P/E range, in line with high-quality branded Consumer peers.

And then there's Netflix...

Disney is getting itself set-up for the digital age. With its recently announced deal with Netflix (NASDAQ: NFLX)Disney will have a new licensing agreement that will bring its movies to the streaming giant after its current deal with Starz ends in 2015.

Streaming movies will most likely add significantly to Disney's bottom line, because margins should increase when the company no longer has to produce physical DVDs anymore. The deal also helps Netflix, which currently has a strong base of over 30-million users, because according to Scott Devitt, an analyst with Morgan Stanley:

The company is focusing on building a highly differentiated content catalog aimed at kids, which is a demographic that has relatively homogeneous tastes.

Netflix is looking to provide more entertainment for children, and who better to help it accomplish this goal than Disney? This gives Netflix much more of an edge as the king of streaming content. The Disney/Netflix relationship should be a win-win.

The multi-year premium deal gives Netflix viewers exclusive access to Disney movies and content-- including pay TV rights to all the new Dreamworks' movies starting this year. Netflix provides Disney with a new digital distribution channel, allowing Disney to move away from cable.

Once the deal kicks in completely, if you want Disney, you will have to go through Netflix. This further cements the company as the king of streaming content. Now if only they could figure out a way to better monetize this streaming content.

Disney will undoubtedly boost revenue significantly, but generating significant new earnings from the added revenue is up to Netflix. The lead over Amazon.com in streaming content is widening further with the new Disney deal, however.

If considering an investment in Netflix, keep an eye on earnings. Netflix's current business model, which consists of charging a low fee for "all-you-can-watch," may not be sustainable for profits long-term.

Still, its subscriber base is expanding rapidly, and Disney's content should set it on fire and carry the growth even further. If you trust the company's word, then there may be a better case to buy its stock-- as they anticipate a 118% increase in earnings per share over the next year. If this growth ever comes to fruittion, Netflix might just be a buy. It's all about earnings.

Fundamentals/Valuations:

Nike looks to be in much better shape financially than Disney. Nike has less debt and is more liquid. Don't count out Disney, however. The company is trading at around 18.5 times earnings, as opposed to Nike, which is trading at a pricey 23 times earnings, approximately. 

Going forward, Disney looks significantly cheaper, as well. Disney's forward P/E is only at about 15, as opposed to Nike's forward P/E of about 19. There may be more to like about Nike's dividend policy, however, which has resulted in increasing distributions lately and offers a quarterly payment yielding 1.4%.

Disney pays out a comparable 1.3%, but it also only pay out once a year-- which isn't as desirable for reinvesting dividends to take advantage of the magic of compounding. Both companies have been steadily increasing their dividends, however.

The bottom line

Nike and Disney are both globally recognized companies that are already deeply ingrained into American culture, and are also expanding their popularity internationally. They both have strong catalogs of iconic brands and past products that still sell well today, and most likely will far into the future. This, along with new products and successes to keep building their catalogs, gives them a wide moat over competitors. The perfect moat, really, for any discretionary growth stock.

Disney currently looks more attractively valued than Nike, but both are expected to grow earnings and make solid long-term investments-- even more so if you are in the boat that believes in even a slight sign of an economic recovery, one that may slowly begin to drift toward higher consumer spending. 


Joseph Harry owns shares of Walt Disney and Nike. The Motley Fool recommends Netflix, Nike, and Walt Disney. The Motley Fool owns shares of Netflix, Nike, and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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