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Finding Recession-Proof Businesses
The economic environment in 2022 is...unstable. The war in Ukraine has destabilized gas prices, driving up the cost of shipping, which, combined with unprecedented government stimulus and historically low rates, has caused pretty dramatic inflation.
Consumer Price Index data released in July 2022 marked Q2 inflation in the U.S and an earth-shattering 9.1%, topping the expectations of even the most pessimistic economists. 9.1% inflation hasn't been seen since 1981, and many argue that we are headed towards stagflation, where wages fall and prices rise, putting the consumer in a Figure Four lock like Ric Flair is there to greet you at the grocery store.
In an attempt to battle inflation, the Federal Reserve is aggressively raising interest rates at the Central Bank, essentially making borrowing money more expensive. This means that growth companies can no longer grow at the same pace they have been during the last 10 year bull market, and the stock market is reflecting that notion.
The stock market has fallen faster than a cougar for Zach Wilson, and now we're seeing companies off of their high's by 20, 30, 40 and even 80% (hey Netflix). So what does this mean? That companies with a bright future are now all of a sudden "on sale." So today, let's take a look at what I'm looking at during this bear market, and how you can find quality companies in the midst of a recession.
FAANG Does Not Mean "Safe"
Since 2008, the FAANG stocks have risen to prominence with both retail and professional investors. The group of Meta Platforms (Facebook), Apple, Amazon, Netflix and Google have obliterated the S&P 500 index returns over the last 10 years, and they essentially make up the Mount Rushmore of global companies. So that means they're clear safe havens for your cash in a recession, right?
Not necessarily. Do I love Apple, Amazon and Google? Yes, and I'm saving those for the next section. However, there are two massive red flag companies in the FAANG family that I would hesitate putting my money into at this moment: Meta and Netflix.
Let's start with Meta. Meta changed their name to Meta because of the Metaverse. What is the Metaverse? Well, right now, it's an interview on the Today show that had one of their anchors meet a weird, Mii-esq version of Mark Zuckerberg. According to Zuckerberg, this is the future. According to shareholders? Not so much. Meta has dumped literally billions of dollars, and changed one of the most recognizable brand names in the world, in order to make this work, and it isn't. Yet. I'm not saying it won't, but the returns and cash right now are giving us a pretty strong indication.
The second member of this weird, inbred Appalachian family is Netflix. The House that Reed Hastings built is in freefall. The stock has collapsed, their original content that they spend $200 million on FOR ONE MOVIE is in the toilet and they're introducing an ad-supported tier of Netflix to lower the price point for hesitant consumers. Even the new season of Stranger Things couldn't save Netflix from losing a further 970,000 subscribers in Q2 2022 (though somehow that's a positive surprise based on their own sandbagging of 2 million lost subs).
In my opinion, Netflix looks ripe for a purchase. But who has enough cash to take on acquiring Netflix?
Look For Cash Stockpiles to Go On Offense
The first place you want to look in a recession is at the cash balance of a company. You want to figure out not only which companies have enough money stockpiled to survive the storm, but to actually go on offense while times are tough.
Think about it. The common wisdom for everyday investors like you and me is "recessions make millionaires," because you can buy up assets at cheaper prices that will theoretically increase in value over time. It's the same principal with companies. So what companies have balance sheets that allow them to get creative?
The first one is what I was alluding to in the previous section, and that's Microsoft. Microsoft was back in the news recently after agreeing to become the official advertising vendor for Netflix's new ad-supported tier. To me, this seems like Microsoft's innocuous foot in the door in order to get a look at how the company operates. Microsoft is an expert in all things tech, including cloud, gaming and software, but they're one of the few major companies without their own streaming service. Netflix is a cloud-based streaming service that wants to expand into advertising and gaming, and they have an expansion problem. I think Microsoft is the key to that expansion problem.
Additionally, Apple is at the top of my recession shopping list for a similar reason. Their streaming service is basically one of two (hey Amazon) where making money doesn't really matter right now. Why? Because Apple has so much money it's ridiculous. They're currently sitting on a stockpile of around $200 billion, and they're adding to that pile every day with their $106 billion in free cash flow. This opens the door for them to get acquisitive, or to generate new products while their competitors are just trying to survive.
Then, there's Alphabet. The mack-daddy of online advertising has no shortage of cash, and recently hit the headlines for wanting to reintroduce their augmented reality glasses to society after the last iteration's spectacular failure. Not to mention that Google has an entire venture capital-type wing of the company that literally invests in "moonshot" ideas in the hopes of finding the next great one.
Finally, companies with tons of cash often have a tell-tale sign that they have, well, tons of cash: the dividend. Companies that pay a dividend either have no more ideas on how to use that cash, or they have so much fucking money that they don't know what else to do with it, so they return it to the shareholders. Both Microsoft and Apple pay dividends, but there are other companies that could be on your watch list in a recession: Dividend Aristocrats.
What Are Dividend Aristocrats?
Dividend Aristocrats are companies that have paid, and raised, their dividend every year for at least 25 consecutive years.
Being on this list is a high honor, because it indicates a few things: that the company has been around for a solid amount of time, and that it's a stable, predictable company. According to U.S News, there are currently 65 U.S-based dividend aristocrats, each of which, at time of writing, are essentially on sale. They're free cash machines that pay out every quarter, and they're on sale. This might be the chance to take a look at one or two to add to the portfolio.
Companies that can invest in new products, new technologies, or even new companies during a recession stand to be the big winners in the years and decades that follow. However, they're not the only ones that can flourish in a recession. Some companies just know how to protect their own downside.
Finding Products That Are Recession-Proof
Think about products or services that you use every day. Really think about it. You have your phone, your internet, your television, maybe some Uber Eats? But go one step deeper: do you take the trash out? Do you run to the grocery store to purchase food? What credit card do you use to purchase that food? Do you pay that credit card bill? If so, with money from what bank?
See where I'm going with this? Some businesses are so sticky, you forget they're businesses at all. Some businesses apply at all times, no matter the macro-economic conditions. I have a few favorites that are currently on my watch list:
Bank Stocks
Bank stocks are pretty high on my list of companies to watch during a recession. Why? Because they technically fall into the above category of "look at all of our cash," but are federally regulated to how they can grow. U.S banks after 2008 are mandated to have extremely high levels of cash reserves, but how many banks do you know that are introducing new products? They're very conservative, and they pay a dividend. They're also sticky as hell to the consumer. Have you ever changed banks? It's a pain in the ass! Finally, banks have multiple products that help them navigate all market conditions, from savings accounts to mortgages to home equity lines of credit, all taking advantage of different macroeconomic environments.
In this, I'm actually going to include American Express. The reason that I prefer American Express to Visa or MasterCard is actually based on their unit economics and how they make most of their cash. Amex has far fewer actual users, but they generate a lot more money per user due to higher merchant fees when people actually purchase things with an American Express card. This actually makes them an excellent play on both a recession, as well as inflation. What a world we live in.
Consumer Packaged Goods
I won't lie to you, reader: I nearly put "grocery stores" here, but then I thought a little bit harder. Grocery stores operate on razor-thin margins, have constant waste and shrinkage and are generally not good investments (not including Costco). So why not purchase the stock of the company that grocery stores stock in their inventories instead?
Companies like Johnson and Johnson, Proctor and Gamble and Unilever are consumer staples. They're cash machines that produce everything from baby formula to deodorant to laundry detergent, all of which I'm pretty sure you need unless you went to live in the woods. And remember those Dividend Aristocrats I mentioned earlier? Many of those are actually CPG companies, so you know that the business is stable in good times and bad.
Pets!
Those of you that don't have a pet won't understand this, but pet-owners would basically spend anything on their pet. That's not anecdotal, that's what the actual numbers tell us. According to The National Pet Owner's Survey, pet owners in the U.S spent over $8 billion on their pets in 2020. Remember what else was going on in 2020? That's right! While many lost jobs, paused mortgage payments and stopped paying student loans, they still had the cash to spend on feeding Fido.
The main sources of pet spending come from two verticals: pet food and pet health.
Pet food spending makes up about 40% of total pet spending, most of which is split between consumer staple brands like General Mills and JM Smucker, both of which have booming pet food businesses. If you don't want to invest in the actual food manufacturer, then looking at a company like Chewy could be a good backdoor into the pet food and toy market.
As for pet health, this one gets a bit more esoteric. The primary breakdowns in this vertical are: veterinary equipment, medications and insurance. Veterinary equipment is dominated by the duopoly of Zoetis and IDEXX Labs. As far as medications, those are generally manufactured by Merck, Eli Lilly and Boehringer Ingelheim's Animal Health division.
Finally, we have pet insurance. This is a rapidly growing industry as millennial pets begin to age with the millennial population, leading to more expensive procedures and more frequent vet visits. The primary pet insurance providers are actually divisions of Allstate, State Farm and Progressive. However, because this market has exploded in recent years, Trupanion has emerged as the leader in pet-specific insurance.
The Bottom Line
When it comes to investing, recessions are all about going on offense. They're about accumulating quality companies with solid businesses for rock-bottom prices. I hope today's article gave you a few ideas on where to start looking so you can begin building your empire one share at a time!
Disclosure: The author of this article has a financial interest in the securities mentioned here. He currently has long financial positions in American Express (AXP), Truist Bank Corporation (TFC), First Horizon Corporation (FHN), Microsoft (MSFT) and Apple Inc (AAPL). The author additionally is employed by First Horizon Corporation (FHN). All opinions expressed in this article are opinions of the author, and should not be taken as investment advice. Please contact an investment professional for your own individual situation.
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