Seven stocks to buy to profit as Generation Z comes of age

Keeping an eye on young people’s spending habits can help you identify promising long-term investments, says Stephen Connolly.

You may not care much whether you’re considered a so-called baby boomer or a member of Generation X – but it matters a lot to some. Marketers and sociologists have built whole careers slicing and dicing society into different generations and telling us how they will behave or what they will buy. Companies and investors have been trying to get in on the act too. Pick up on the trends of the future, the thinking goes, and the profits are sure to follow.

It isn’t quite as easy as it sounds, of course. Holding a broad basket of stocks linked to, say, millennial themes (millennial applies to the generation born between the early-1980s and the late 1990s) hasn’t been especially rewarding compared to investing in global markets as whole.

For one thing, it’s not always clear which companies fit the bill. What are the hallmarks of a millennial business? Housebuilders and banks are helping them get hold of loans and property, for instance, but then they have older customers too. And even if you’re confident you’ve found a firm catering exclusively to a certain demographic, what if the managers are no good?

The “takeaway generation”

Still, don’t dismiss the generation game out of hand. Each one has distinct preferences. For instance, millennials’ emphasis on personal health and dislike of alcohol has reduced demand for beer; a plethora of online food delivery services has engendered a “takeaway generation”; and their preference for shopping online has contributed to the decline of the big department stores their parents used.

Being alert to and tracking consumer shifts early has helped investors profit from the winners and avoid the losers. Generational impacts go far and wide: brands such as Gillette have struggled because people shave less these days; toy sales have come under pressure as fertility rates have slipped; and even soap bar sales are down because younger millennials in particular see them as “germ bars”.

Such trends can strengthen as each generation swells. The youngest generation, for example, is Generation Z (Gen Z), comprising those born from the late 1990s onwards. Over time there will be billions of them – a huge group of consumers. They already fill universities, are entering the workplace and have started to earn.

There’ll be the usual milestones such as marriage, children and first family homes, each of which will affect businesses in unique ways. What types of weddings will people want in 15 years’ time? How may children will be affordable? Will people rent for even longer before buying homes? And what will they spend any spare money on?

The first clues to the future

One well-regarded study comes from the US investment bank and manager Piper Sandler. It’s been surveying thousands of Gen Z respondents for years. Reading the surveys allows us to gauge how teens are spending their money as well as their future aspirations within six broad areas: social media, shopping, make-up, clothing, dining and videogames.

We take nothing for granted from these young early consumers but they will come to dominate the business landscape – their thinking matters. Making an early attempt to link their perceptions and preferences with already well-regarded and successful companies could give investors’ portfolios a long-term fillip. So what do the surveys tell us? First, there are the “basic needs”, defined as electronics, cars and similar items. Then there’s the “selfie budget” which is about appearances and the perceived need to be selfie-ready – think clothes, shoes and personal care. And finally, the “social budget” which includes eating, music, movies and other entertainment.

A whopping 85% say they own an iPhone from Apple (Nasdaq: AAPL) and 88% say it will be their next phone too. As for social media, Instagram remains the most frequently used app, closely followed by Snapchat. The former, like message service WhatsApp, is owned by Facebook (Nasdaq: FB), one of the early social media pioneers and itself favoured by Gen Z, currently in fifth place.

A boost for Facebook’s e-commerce venture

Facebook’s recent move into e-commerce with Facebook Shops, which lets businesses build virtual shopfronts across all its platforms, has been well-received at a time when many customers are hard to reach.

Analysts are positive, with Deutsche Bank, for example, making a strong case for $30bn of future e-commerce sales – a big jump given that the group’s overall sales reached $70bn last year. It’s a long-term buy, and my positive stance is tempered only by the likely near-term political scrutiny of the social-media sector in the run-up to the US elections later this year.

An alternative player in e-commerce is, of course, Amazon (Nasdaq: AMZN). Gen Z can’t get enough of it. Over 50% of respondents favour it, putting it miles ahead of its nearest online rivals. It is hardly surprising, then, that it has been a top performer this year – up 34%, largely on the back of lockdown. Too high to buy? Betting against the stock has often proved costly. Most analysts are “buyers” and the target share price is higher. It is a pure growth play and it is about more than e-commerce.

It’s a big bet on cloud computing, the trend whereby firms increasingly store or manage data and deliver IT services online rather than in-house. Amazon is the biggest player in this field ahead of Microsoft.

An exception to the online shopping rule

An interesting exception to the inexorable online shopping trend is cosmetics: 90% of Gen Z consumers (and others) want to buy them instore. The obvious reason is that buyers can experiment and find different looks alone or with friends and the stores’ experts before buying. Another is that shoppers can be sceptical about online cosmetics’ quality and origins. The stock to watch here is Ulta Beauty (Nasdaq: ULTA). It has struggled of late and the lockdown hasn’t helped but this should turn around as people go back to work and socialising returns. Turmoil at the competing larger department stores such as JCPenney and Macy’s also bodes well.

Ulta is pushing ahead with physical sales while seeking to build on the double-digit sales growth it has generated in lockdown. It’s already the favourite destination beauty store for 40% of Gen Z. Its tech-savvy and pioneering virtual-reality make-up facility (allowing you to test make-up on digital faces) is a key plus point. I think Ulta can gain market share through innovations such as these.

Athleisure in, Ralph Lauren out

What Gen Z goes on to wear its make-up with is altogether more complex. Women are increasingly opting for trainers, or at least athletic-branded shoes, and preferably Nike (NYSE: NKE). While 90% of men want trainers, now 80% of women do too. In fact, 37% of both groups veer towards athletic clothing generally, which does not bode well for the likes of Ralph Lauren. Chinos are out while hoodies and leggings are in.

Nike is an unparalleled brand leader among teens and continues to see off the competition. A huge one in four give it the top spot. Compare that to just one in 20 for Adidas. When it comes to trainers alone, 47% want Nike but only 11% want Adidas.

I’ve successfully recommended Nike before. Cutting out retailers and selling directly to its customers will – together with breakthroughs in newer materials, accelerating speed of production and highly-targeted marketing – reward investors. Unsurprisingly, Nike is Gen-Z’s second-favourite online place to shop after Amazon.

But while Gen Z might be dressed for athletics, how active they really are isn’t clear. Of all teens, 94% own a videogames console. Nearly two-thirds say they’ll be buying the next consoles, which is great for the industry as a new generation launches this year. Consoles remain a popular way to play videogames. Significant numbers also play on mobile phones. Spending on the games themselves show no signs of declining from a steady $200 or so a year.

I’ve been recommending video games publisher Activision Blizzard (Nasdaq: ATVI) for years. A key factor has been fattening profit margins as games are downloaded digitally rather than sold as cartridges. Younger enthusiastic players will accelerate the trend. Activision has a great portfolio of big $1bn titles including Call of Duty, Overwatch, World of Warcraft and Candy Crush.

When Gen-Z is not online but out and about relaxing, it often chooses Starbucks (Nasdaq: SBUX). The firm’s ranking can be volatile, however, though Piper Sandler notes it remains the most preferred brand among teens of any quoted company. The stores have been reopening from lockdown recently and the group boasts good management, a healthy balance sheet and excellent customer loyalty. It is very strong in its key markets and has good revenue growth, proving adept at identifying new ways to grow and push expansion overseas.

Stephen Connolly writes on finance and business, and has worked in investment banking and asset management for over 25 years (sc@plainmoney.co.uk)

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