CONSUMER DISCRETIONARY SECTOR IN INDIA (Key Fundamental Ratios)

Fundamental Ratios used to analyze stocks in the consumer discretionary sector can be divided into 5 categories- namely Valuation Ratios, Solvency Ratios, Profitability Ratios, Efficiency Ratios and Liquidity Ratios.

VALUATION RATIOS

1. P/E Ratio

The price-to earnings ratio is an important valuation metric used to analyze companies across industries. Companies within the consumer discretionary sector tend to have a high P/E ratio and are consequently classified as Growth stocks. These stocks tend to be overvalued in light of the growth potential they face in a growing economy such as India, where incomes are on the rise and, along with it, discretionary spending. The price-to-book value can also be analyzed to determine if a stock is overvalued or not. Apart from the above two ratios, the dividend yield of a stock is an important metric that can greatly impact market sentiment surrounding the company. Undervalued Stocks, i.e., stocks with low P/E and P/B ratios that have a high dividend yield, are classified as income stocks. Auto stocks such as Maruti Suzuki have high growth potential and manage to provide above average dividend yields to investors without compromising on revenue growth rates. These companies are classified as Growth-Income stocks. Companies that do not belong to any of the above categories are classified as Core.

INFLATION

As can be observed from the graph below, the performance of the consumer discretionary sector is inversely related to inflation rates. Inflation is detrimental to the sector. Consumer discretionary products are highly price elastic in nature. This implies that even a tiny change in prices can cause a huge change in demand for these goods, adversely affecting the sector's revenues. A sharp drop was witnessed in inflation rates in the year 2018 as food prices cooled down. This had a positive impact on the consumer discretionary sector. High inflation, along with monetary tightening to combat the same, adversely affected the sector in 2022–2023.

INTEREST RATES

A drop in interest rates can be beneficial to the consumer discretionary sector. Low interest rates translate into low costs of production and further into lower prices, boosting demand and spending by consumers. Discretionary spending on cars, electronic equipment etc also increase as loans for the same can be availed at lower rates of interest. Accommodative monetary policies implemented by Central Banks across countries led to a decline in interest rates IN FY 21. Subsequently interest rates across the globe have been on the rise to help combat inflation rates, adversely affecting consumer spending.

EXCHANGE RATES

An increase in exchange rates will be favorable for export oriented sectors within consumer discretionary, such as auto and textiles. However, this can also raise the cost of production by making imports more expensive. If the latter occurs, demand for these goods will fall on account of high prices and cause a dent in the stock's value.

COMMODITY PRICES

The performance of the consumer discretionary sector is inversely related to commodity prices, as can be seen in the graph. Increased commodity prices directly translate to higher production costs. Since this sector is highly price elastic, any rise in prices leads to a sharp fall in demand. Higher commodity prices can also erode the disposable income of individuals, leading them to spend less on discretionary items such as cars, media, etc.