Despite Headwinds, Consumer Discretionary Sector is a Solid Contrarian Bet

Over the last few months retailers have had a tough go of it. Even companies that continue to hit their numbers have seen their stocks fall by 30% or more. We all know the bearish arguments for the consumer discretionary sector. Higher interest rates, flat real wage growth, high gas prices, ARM's adjusting for many home owners, etc.

While I agree these are all issues facing the U.S. consumer, I don't think we should slash every consumer discretionary company's stock price by a third. One must be selective, but there are companies out there that aren't doing as poorly as their stock prices indicate, and shouldn't later this year or next year either.

Take for instance the upper class high end consumer. Are these issues going to adversely affect them to a large degree? I'd argue that $3 gasoline and variable rate loans will squeeze the low income earners a lot more. They are the people who took out the interest-only or 3/1 ARM mortgages because it was the only way they could afford the house they wanted to buy. A tank of gas going from $30 to $50 is not going to crimp the richest 5% of America.

Moving to a company specific situation, consider the luxury goods maker Coach (COH). I started buying the stock recently at $25 and change and it's the first time I've ever even considered buying shares. The stock traded at 25 or 30 times forward earnings whenever I looked at it. Even a 20% growth rate couldn't convince me that it was a bargain at those levels.

The company has continued to hit its numbers and I expect more of the same when they report in early August. However, the stock took a dive along with the other retailers. Down from a high of $37, the stock traded at about 18 times 2006 estimates of $1.39 per share. Twenty percent growth in 2007, which I think is very doable despite the economic climate, puts the forward P/E at 15. While still a market multiple, a high end luxury goods leader like Coach looks attractive at such a price and even has $2 in net cash on the balance sheet.

I also want to mention a long time favorite, Sears Holdings (SHLD). Along similar lines, SHLD shares are down $30 from the highs set after they blew out first quarter estimates. Since the company is benefiting more from a turnaround in operational efficiencies, as opposed to shoppers banging down the doors at their stores, I expect another solid quarter when they report next month. We could very well get a post-report pop in the stock if such a scenario plays out, making the $30 correction look quite silly in hindsight.