Not-So-Bleak Future for Consumer Discretionary

• ByArne Alsin, RealMoney.com Contributor
• On Monday December 1, 2008, 1:16 pm EST

Everybody knows the consumer is a dead man walking. The stock market predicts he or she will continue to buy toothpaste, breakfast cereal, deodorant and not much else. This is no time to replace the washing machine. A new car? Yeah, right. It's preposterous to imagine consumers rebounding anytime soon, not when they're in debt up to their eyeballs.

Only a loon would tell you to buy certain consumer discretionary stocks. So, call me a loon, but this bird expects to make three to five times his money on stocks in this sector. And to accomplish that, I don't need consumers to make anything close to a complete recovery.

Consumer stocks are divided by needs and wants. Companies in the consumer staples category, such as Procter and Gamble , sell needs such as toothpaste and deodorant. Consumer discretionary businesses, on the other hand, sell wants -- chock-full of bargains, this category includes retailers, restaurants, homebuilders, toymakers and travel-related companies, among others.

Over the next three to five years, owners of consumer discretionary stocks like Expedia , Overstock.com , CarMax and Brunswick will see their stocks soar by 300-500%. A chunk of that is due to the rebound effect, but this gain will also inure from the companies' ability to rapidly adjust to a changing environment. This analytical layer is critical for consumer discretionary stocks: The big winners will be companies that can capture share coincident with adjusting to a smaller end market. The companies with flexible cost structures -- heavy on variable costs, light on fixed costs -- stand the best chance.

The only way to make 300-500% betting on selected consumer discretionary stocks is if the market has made a serious mistake. It has. It's not a mistake "in fact" -- consumers have been hurt, after all -- but it's a mistake in magnitude. Stocks that deserved a 20% haircut have been blistered by 80% or more.

Are fourth-quarter earnings numbers for consumer discretionary stocks going to be awful? Of course. Are we going to see more of the same in the first and second quarters of next year? Yep. So why buy now? Because the spread between price and value is massive.

Investors, take note: the value of a business is not predicated on any one quarter's or year's results. The value of a business approximates the present value of its future cash flows over many years, some of which will be remarkably good and some of which will be stinkers.

Even though the stuff of business is and always will be cyclical, the market sees stocks through a linear lens. What's happening now is linearly extrapolated out into the future, as if the economy will continue its funk until the 22nd century - a mistake the market makes in periods of both extreme enthusiasm and extreme pessimism.

If you insist on waiting for the economy to improve before investing in selected consumer discretionary stocks, you'll pay a hefty price. The stocks will adjust well in advance of better economic news. To maximize your profit, you have to steel yourself for a boatload of bad news and dig in. But you also have to anticipate that by this time next year, certain consumer discretionary companies will be beating year-over-year quarterly numbers by a country mile.

The setup for that event is occurring right now: The quarterly comparison bar for 2009 is set so low that a one-legged gnat could step over it.

Know What You Own: Other consumer discretionary stocks include Orbitz and Amazon .