Best Consumer Discretionary Stocks for 2016

By Markets

Image source: Getty Images.

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Consumer discretionary stocks, those stocks made up by companies that sell non-essential but desirable goods, are increasingly becoming expensive as a sector. The Consumer Discretionary Select Sector SPDRFund(NYSEMKT: XLY), an exchange traded fund (ETF) that tracks the biggest consumer discretionary companies, is made up of many companies that are easily recognizable to most investors. Here are the top holdings:

Company Weight Within ETF 14.1%
Comcast 6.7%
Home Depot Inc. 6.7%
Walt Disney Company 5.6%
McDonald's 4.2%
Starbucks 3.3%
Priceline Group 3.1%
NIKE Inc. 3%
Lowe's Companies Inc. 2.6%
Time Warner Inc. 2.6%

Data as of Oct. 11, 2016.

Rising consumer confidence, which climbed in September to 91.2, up from 89.8 in August, along with lower unemployment, has helped this entire sector to gain value over the last few years. This XLY ETFhas quadrupled in just eight years following the Great Recession.

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XLYdata byYCharts.

While all of this impressive growth may look appealing for investors looking to jump in now, be careful: It's also somewhat expensive at an average P/E of 20 times for the underlying stocks, even though many of them have less than inspiring growth prospects. But while the sector as a whole is pricey, individual stocks within it could have great return potential going forward. Here are some of the best consumer discretionary stocks to buy now.

1. Amazon

Amazon(NASDAQ: AMZN) takes the top spot of the XLY ETF with a heavy 14% weighting, more than twice the second-place holding. Of course, that's for good reason, as Amazon has grown so much in just the last few years, and now Q3 earnings are expected to come in 371% higher than a year ago. However, this growth is coming off a small base, since Amazon isn't very profitable.

Having a higher P/E isn't necessarily a reason to overlook a stock, so long as the company can prove the growth to back it up.Amazon is expensive compared to the rest of the stocks in the fund, trading at around 200 times trailing-12-month earnings. However, with such rapid earnings growth, Amazon's P/E is expected to drop to just 43 times 2018 earnings at today's price.

Of course, the investing thesis for Amazon is that it will continue to grow rapidly -- far beyond 2018 -- and will likely continue to hold a high P/E, meaning that the stock price should rise steadily as earnings do.With growth in so many areas -- not just e-commerce but also media streaming, physical devices, and even "moon shots," such as delivery drones -- Amazon's growth story looks intact.

2. Nike

Nike (NYSE: NKE) is an example of a greatcompany that has fallen out of favor and now looks like a compelling investment. Nike is also more expensive than the group's average at around 23 times earnings, but it looks like a buy as it is expected to continue to growing in the coming years. Nike's shares have fallen over the last year because the company has reported slowing sales growth, down to a low of just 6% growth year-over-year in fiscal year 2015.

That growth picked up to 8.3% year over year in the recent Q1 and is expected to rise more in the quarters to come.Thanks to growing e-commerce sales and investments in markets like China, Nike's long-term sales and earnings growth still looks strong, making this a valuable play during the recent price dip.

3. Disney

Disney (NYSE: DIS) is another stock that has fallen out of favor recently, though its fundamentals and growth prospects still look strong, making a rare opportunity for investors to buy into one of the most diverse and well-run companies in the market for the low P/E of just 16 times. This is in light of the fact that in the most recent quarter, Disney's sales rose 9% year over year, while EPS rose 10%. Analysts expect EPS to grow 10% on average each of the next five years.

Wall Streethas lost confidence in Disneyover the last year after it reported falling subscriber rates for ESPN, an important brand that has been its largest cable networks property. While cable networks is Disney's largest segment, it's one of the company's slowest. Instead, theme parks and studio entertainment are driving earnings growth now.

Image source: Disney.

With a new theme park recently opened in Shanghai this summer and continual blockbuster movies in multiple categories, including Star Wars and Pixar films, it's a foolish (little f) to bet against this company.Perhaps even more exciting is that the behemoth cable networks segment still has plenty of potential for future growth by altering its delivery method to take advantage of the cable cord-cutting trend. Disney's recent investment in streaming service BAMTech shows that potential.

How to play this sector

There are many ways that investors can play this sector, from individual stocks like those listed above, to buying into an ETF or index that weights companies based on their size, to ETFs that weight holdings by different metrics, such as theAmplify Online Retail ETF, which is made up of companies that generate at least 70 percent of their revenue from online sales.

A diversified portfolio may benefit to some exposure to the consumer discretionary sector, and there is plenty of value to be found if you just know where to look.

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Seth McNew owns shares of Nike and Walt Disney. The Motley Fool owns shares of and recommends, Nike, Priceline Group, Starbucks, and Walt Disney. The Motley Fool recommends Home Depot and Time Warner. 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.