Investing in Luxury Stocks

You may not be able to define luxury, but chances are good that you know it when you see it. Luxury goods are the opposite of necessities. They’re high-end products that consumers want but don’t need. They’re also distinct from commodity products (such as bananas or gasoline) that are not easily distinguished by brand.

Luxury goods are more expensive than competing products, but they are perceived as higher quality and confer status on the owner. Because of that relationship, brand is a crucial component of a luxury stock.

The best luxury stocks include strong brands, high operating margins, and timeless products.

Being non-necessities, luxury goods resemble high-priced discretionary goods, making them the opposite of consumer staples, or everyday products such as groceries that consumers buy because they need them. Although luxury goods may sometimes be durable goods such as cars, they can also be consumables such as cosmetics or cigars.

Investors most often think of retail products when they think of luxury. Those may include fashion from brands such as Burberry Group (OTC:BURBY); Jimmy Choo, which is owned by Capri Holdings (NYSE:CPRI); or Stuart Weitzman, which belongs to Tapestry (NYSE:TPR). However, the sector goes beyond retail to include travel, food and dining, and even services.

Best luxury stocks to buy

The chart below shows three of the top luxury stocks you can buy this year.

The three stocks have outperformed the S&P 500 (INDEX: ^GSPC) in recent years and have benefited from a bull market, an expanding global economy, and increasing wealth among upper-class consumers who profited in the pandemic stock market boom. Because these companies count on wealthy customers, their performance is highly correlated with macroeconomic indicators such as the stock market or real estate prices. More recently, they cooled off during the first half of 2022 amid a stock market pullback and fears of a recession.

1. RH

RH, the company formerly known as Restoration Hardware, has mastered the market for expensive home goods. The company sells items that include $5,000 dining tables and $8,000 leather couches based on a modern and contemporary design motif. RH uses mailed source books and thick catalogs to stimulate demand, and it sells its wares from a handful of splashy galleries across North America. Under the leadership of CEO Gary Friedman, the company successfully pivoted to a membership model, selling annual memberships at $100 in exchange for 25% discounts on merchandise. The policy has encouraged repeat purchases and customer loyalty.

Its next step is transitioning to a lifestyle brand as the company plans to open up hotels, restaurants, and private jets, and launch a streaming service based around architecture and design.

Still, 2022 is shaping up to be a slow-growth year for RH as consumer spending shifts from home furnishings, but the brand and the business model remain strong.

2. LVMH

LVMH is the world’s biggest luxury company and is valued at roughly $300 billion. The company has diversified holdings in wine and spirits, luxury fashion and leather goods, perfumes and cosmetics, and jewelry and watches, among other businesses. It’s been a prolific acquirer of luxury brands, adding Officine Universelle Buly, a French perfume and cosmetics company, in October 2021, and Tiffany in January 2021. In recent years, much of the company’s growth has come from mainland China, where an emerging upper class and a culture of conspicuous consumption has supported growth across much of the luxury market.

In a difficult macroeconomic environment in the first half of 2022, LVMH has delivered standout growth with revenue up 28% to $36.7 billion. Organic revenue, which excludes the impact of acquisitions, divestitures, and currency exchange, was up 21%. Profits were strong as well, with operating income up 34% to $10.2 billion and an operating margin of 27.9%.

3. Ferrari

Ferrari, the high-end sports car maker, employs a classic luxury selling technique. The company limits its production to support high prices and wide operating margins. Artificial scarcity, as this strategy is known, helps create demand for a product as it becomes an exclusive status symbol. Since not everyone can have one, people naturally want it more.

Ferrari’s management has argued that the company should be valued more like a luxury company than an automaker, and it earns a higher multiple than its auto sector peers. Like LVMH, the company has found a ripe market in China, and it’s burnished its profits by selling limited-edition cars at prices topping $1 million.

Performance remains strong through the first half of 2022 with revenue up 21% to $2.5 billion, and it reported a 25% operating margin.

How to find the best luxury brand stocks

Luxury companies are distinct from most companies in a number of ways, especially in the relationship between desirability and price, so there are some important differences to be aware of.

Because rapid growth can dilute a brand -- especially if that growth is coming from a mid-market customer base -- high revenue growth is rare for a luxury company and is not the most important factor for investors. Instead, investors should consider the strength of its brands, which can often be measured by a company’s pricing power, or how expensive its items are when compared to competitors’ prices. Operating margin is the most important metric because it shows how successful the business is at converting revenue into profit. Investors should expect luxury companies to generate high operating margins; 20% or more is ideal here.

While investors tend to think of companies such as LVMH, Hermes (OTC:HESAY), or Gucci owner Kering (OTC:PPRUY) as core luxury brands, luxury status extends beyond fashion and retail, and some companies have elements of a luxury business inside a larger one. Nike’s (NYSE:NKE) Jordan brand, for instance, uses artificial scarcity to drive sales of its basketball sneakers, which often fetch top dollar on the resale market. Starbucks (NASDAQ:SBUX) has followed a similar playbook with its reserve roasteries and premium coffees, and Airbnb (NASDAQ:ABNB) offers luxury home rentals through Airbnb Luxe. Apple (NASDAQ:AAPL) and Tesla (NASDAQ:TSLA) serve as additional examples of companies that have successfully straddled the luxury and mass markets.

Are there any luxury ETFs?

For investors looking for an easy way to get exposure to a broad range of luxury stocks, the best way is through an ETF, or an exchange-traded fund. The one that tracks the S&P Global Luxury Index (INDEXSP:SPGLGUN) is the Amundi S&P Global Luxury ETF (GLUX.MI), which trades on a number of European exchanges.

The top 10 holdings in the S&P Index and the Amundi ETF are Tesla, LVMH, Kering, Richemont (OTC:CFRUY), Daimler (OTC:DDAI.F), Estee Lauder (NYSE:EL), Hermes, Nike, Pernod Ricard (OTC:PDRDY), and Diageo (NYSE:DEO). As you can see, the list comprises a range of consumer products, including fashion, cosmetics, alcohol, and autos.

The luxury sector has been a strong performer over the past decade, but it is susceptible to market pullbacks and recessions. Consumer spending on luxury products tends to fall in difficult times as wealth is lost.

Should I invest in publicly traded luxury companies?

Many of the world’s most powerful brands are luxury companies, and such brand power brings significant competitive advantages and big profit margins. Luxury stocks have a place in almost any portfolio.

Luxury stocks also have a history of outperforming the broader market, and, since the sector is made up of companies that have proven themselves, they are relatively low-risk investments. Although they are cyclical, a number of trends favor luxury stocks over the longer term. These include the emergence of the luxury goods market in China and an expanding wealth class in the U.S. and Europe, which has increased the market for luxury goods.

The drivers of luxury demand, such as the desirability of exclusivity and status, are also timeless -- which means this sector should continue to beat the market over the long term as well.