AMZN - 3 Stocks To Avoid As We Near The End Of Reckless Consumer Spending

Summary

• Consumers have been overspending their income.
• Spending behavior is about to tighten.
• These companies will be heavily impacted.

Consumer spending has been loose for the past 2 years. It has propped up the revenues of companies that sell discretionary products and services. We are on the cusp of a shift in consumer spending that will drastically change the outlook for certain consumer facing companies.

• Those which sell high felicific ROIC products will continue to do well.
• Those which sell low felicific ROIC products will fail.

What the heck does that mean?

Allow me to introduce a concept for analyzing consumer discretionary companies: Felicific ROIC.

For an investment, ROIC is the financial Return on Invested Capital. For a luxury purchase, felicific ROIC is the happiness return on invested capital. In other words, it is how much incremental happiness a consumer gets from spending on a given item or service relative to the cost of that item or service.

In the past 2 years, felicific ROIC has not mattered because consumers have generally had such an abundance of discretionary income. They could simply buy everything they wanted, and they did.

I posit that this loose spending behavior is about to change and the resurgence of thriftiness will be the death blow to wasteful products/services.

In order to understand why reckless spending is about to end, we first must grasp what caused it in the first place.

The Dawn of Reckless Spending

In previous generations one would start at the bottom of the job market and work their way up over time. It resulted in reasonably low discretionary income which forced people to make choices when it comes to spending. They learned to do an informal equivalent of ROIC analysis on their discretionary spending.

This dynamic changed for the millennial generation. Clearly this is a generalization, but broadly speaking this generation acquired a set of tech skills that was not as prevalent in older generations and this particular skillset has been in high demand. As a result, many millennials skipped the ground floor of the job market and entered directly into very high paying jobs.

That is fantastic, but at the same time it resulted in entirely skipping the phase of low spending power. These high paying jobs combined with not yet having children meant that many immediately had huge disposable income.

Without scarcity there was no need to develop thriftiness. Frankly, the spending habits are irresponsible for many of those who entered the job market directly into high paying jobs. There are plenty of fiscally responsible individual people out there, but at a broad level I think the above statement holds true.

Spending has been getting increasingly loose over the past decade, but it really came to a crescendo in the post-pandemic era as stimulus checks and saved up money from when we just sat at home for a year combined to form a mountain of excess cash.

The conditions which facilitated the loose spending behavior are reversing.

The End of Reckless Spending

Consumer finances are taking 3 big hits sequentially:

1. Inflation increasing the cost of the same purchases.
2. Depletion of cash and accrual of debt.
3. Layoffs of white-collar workers.

I will keep the inflation discussion brief because it is already well known. Put simply, living costs more now and wages have not kept up.

The cash reserves built up during the pandemic have largely been spent and now debt balances are starting to increase at a rapid pace. In the 4 ^th quarter, consumer debt hit a record level.

With increased interest rates, this debt is increasingly hard to carry and default rates are starting to rise on auto and credit card debt.

Finally, while the job market remains strong at an overall level there is a pocket of significant layoffs of white-collar tech workers. Below is a list of the top layoffs and the reduced payments to employees.

These, along with a few others, total 84,179 layoffs recorded in just the last few months resulting in reduced compensation of $11.85B.

Some are still making tons of money and have plenty of cash to finance their spending habits, but an increasing number are going to have to cut back.

I think the group in which the spending reduction is going to be most potent is the same group experiencing the layoffs - young, educated and somewhat affluent. They will still have decent incomes and will still spend, but in a more measured way. Their analytical skills make them entirely capable of executing felicific ROIC decision making, they just haven’t had to yet.

Until now.

More discretion in discretionary spending

A full-scale recession results in significantly reduced overall levels of spending.

With the labor market and GDP both still strong it doesn’t really seem like a recession. I think this will be more of a shifting of spending with elimination of some of the more egregious spending.

As such, I don’t think it will hurt something like the consumer discretionary ETF ( XLY ). This features companies like Amazon ( AMZN ) and Target ( TGT ) which are generally reasonable places to shop even when tightening one’s budget.

Instead, I think the damage will be to companies that rely on consumers spending recklessly. Or to phrase this more formally, the financial hit will be to companies that sell goods or services with low felicific ROIC.

As philosophers who study utilitarianism can attest, anytime happiness or personal utility gets involved the math gets fuzzy. The utility of a given input to an individual is in the eye of the beholder. What might be low felicific ROIC to one person might be high ROIC to another. Thus, one cannot determine with certainty which companies are low felicific ROIC, but I think there are some areas where spending money just doesn’t make much sense as resources get more scarce.

Here are some areas that I think have particularly poor happiness return on cost:

• Dog Spas
• Third party delivery services
• Self-storage units
• First class plane seats
• Expensive restaurants
• Redundant subscriptions

These are the sorts of items that will be foregone as consumers cut back on spending.

Investment implications

While things like airlines might be hurt by consumers pulling back, the airline stocks trade at fairly cheap valuations so it is possible the pullback is already priced in. Instead, the dangerous stocks are those that trade at outrageous valuations AND have deteriorating fundamentals.

Here are my top 3 avoids based on this notion of felicific ROIC:

At Risk #1) DoorDash

DoorDash (DASH) trades at a 640X multiple on peak earnings which were supported by the reckless spending. I think it will be easy and obvious for people to save $30 by just eating a home-cooked meal rather than having food delivered. I think demand will plummet causing reduced revenue and further pressure DASH’s almost non-existent margins. Such an outcome would be devastating to a stock that is currently pricing in a massive amount of revenue growth and margin expansion.

At Risk #2) Netflix

Individually, each of Netflix ( NFLX ), Disney+ ( DIS ) and Hulu provide what I would consider strong felicific ROIC. The number of hours watched relative to the cost is an excellent ratio for the consumer. However, the on-demand nature and nearly 0 switching costs creates an easy avenue for customers to save money.

Currently many have subscriptions to 2, 3 or even 4 of the streaming services simultaneously. For those looking to save money it will be 1 service at a time in rotation. 3 months of Netflix watching everything that looks good then cancel it and do 3 months of Disney, binging the good content.

In brief, Netflix and Disney and Hulu will become Netflix OR Disney OR Hulu.

Although the streaming stocks got beat up in 2022 they bounced strongly in 2023 which has taken them to multiples which require strong growth. In this environment, I think churn will rise and growth will not be sufficient to justify their multiples. In my opinion, Netflix is the riskier stock because Disney’s business is sufficiently diversified that it could do well even if streaming takes a hit.

At Risk #3) Public Storage

I have long believed that self-storage units are a terrible deal for the customer. It is a few thousand dollars a year to store what is in many cases is worth less than a few thousand dollars.

The pandemic was the greatest demand generator of all time for storage units. This business is known to thrive on the 4 Ds:

• Dislocation
• Divorce
• Death
• Downsizing

During the pandemic, people moved in record numbers (dislocation). Many tragically died and while not technically downsizing, the creation of home offices forced people to clear out in-home storage rooms to turn them into offices. The displaced furniture and other stuff got put in self-storage units.

Right now, Public Storage ( PSA ) is priced as if the pandemic driven demand spike is secular in nature. I think it is far more likely the demand will reverse. Tightened consumer cash levels provide the impetus for people to review their spending. I think there will be quite a few realizations of “am I really spending $2K a year storing this junk!?”.

As churn increases and the wave of self-storage developments comes online, high industry-wide vacancy will force price competition among the fragmented self-storage providers. Priced at 19X forward FFO (REIT earnings equivalent), PSA shareholders are expecting smooth sailing.

For further details see: