3 Stocks to Beat a Recession

With the Dow just above the 12,000 mark again, but the threat of a double-dip recession still palpable, it would do investors well to consider the impact a renewed downturn might have on their portfolios. It might be tempting to move to an all-cash position, but before you make such a hasty move, take the time to look at stocks that have the ability to hold up in tough times.

I used the Motley Fool CAPS supercomputer to look for companies that have proven to be less volatile than the market, but which have been reporting strong revenue and earnings growth over the past few years. With a beta of one or less, these companies ought to react less violently to any market swoon.

By adding in a measure of cheapness -- these stocks also carry a P/E ratio that's less than average -- we build in a margin of safety. However, with the CAPS community according them high ratings, we're getting companies that are expected to outperform.

Below are a handful of stocks that look like they could do well in any extended downturn.

Stock

CAPS Rating
(out of 5)

3-Year Avg. Beta

3-Year Avg. Rev. Growth

3-Year. Avg. EPS Growth

P/E Ratio

AmTrust Financial Services (Nasdaq: AFSI  ) ***** 0.7 28% 24% 8.6
El Paso Pipeline Partners (NYSE: EPB  ) ***** 0.2 133% 47% 16.0
Fifth Street Finance (Nasdaq: FSC  ) ***** 0.8 71% 36% 20.8

Source: Motley Fool CAPS Screener.

The long-term view
Being a niche insurer can be a lucrative business, particularly when you're concentrating on lines that are often overlooked by larger rivals. AmTrust Financial Services not only provides workers' comp insurance to small and medium-sized businesses like restaurants, strip malls, and doctors, it also insures some quirky policies, such as paying for legal expenses in the event of unsuccessful litigation and paying for emergency home repairs in the event your plumbing, electrical, or heating systems fail. AmTrust is also behind those extended-warranty programs salesmen are always pushing on you.

It's not without competitors, though. RLI likes servicing that niche, too, because it is less regulated and customers vie for services on more than just price. Hallmark Financial Services  (Nasdaq: HALL  ) also covers higher-risk individuals and businesses, such as health-care professionals who can't get coverage elsewhere because of higher loss histories.

Insurance, regardless of the niche, remains cyclical, ranging from periods of excess capacity (a soft market) to high premiums and a shortage of underwriting capacity. AmTrust went through a soft market between 2008 and 2010, and this year may prove to be the start of a change in fortunes, though it's often volatile. Investors sent shares plummeting last week when the insurer offered senior convertible notes.

Yet Wall Street is unanimous in its opinion that AmTrust can beat the market indexes. You can add the specialty insurer to your watchlist and tell us on the AmTrust Financial Services CAPS page if you think it can continue heating up a portfolio.

A conga line higher
Investing in oil and gas storage and transmission facilities is like betting on the basics of an industry. Despite the best efforts of the alternative-energy crowd, we're not weaning ourselves off fossil fuels anytime soon, meaning we need a way of getting oil and gas from where it's drilled to where it's stored.

Such picks-and-shovels companies El Paso Pipeline Partners and Energy Transfer Partners (NYSE: ETP  ) represent just two of the many well-placed investments that generate strong, stable, recurring streams of revenue. With a payout ratio of 87% and a dividend yielding 5.9%, El Paso is a solid performer that will generate high returns for investors throughout the period of rising energy prices, which is why CAPS member mk1racing is attracted to it: "oil and gas pipeline, MLP(s) when adding growth and yield are the best investments available today."

But now that Kinder Morgan has agreed to purchase parent El Paso (NYSE: EP  ) , ownership of the pipeline assets will come under Kinder Morgan's aegis. Follow along to see whether regulators object by adding the master limited partnership to your watchlist.

Dialing up growth
Finding tomorrow's growth stocks today is what business development companies (BDCs) like Fifth Street Finance hope for, which looks for companies with annual revenues between $25 million and $250 million to invest in. And because capital is still scare for such small to midsized businesses, Fifth Street ought to be able to generate healthy returns on its investments.

The BDC minimizes its risks by putting up capital alongside private equity investments, but three-quarters of its portfolio is first-lien loans, so it remains at the top of the food chain in returns. Volatile markets can wreak havoc with such small companies, though, as American Capital (Nasdaq: ACAS  ) found out a few years ago when it defaulted on its loans and teetered on the brink of oblivion.

CAPS member balcobulls understands the risks, but is willing to ride out the bumps for the potentially heightened returns:

Holdings are just risky enough to provide outstanding interest rates for the investor when interest rates start rising. This company has outstanding fundamentals with a positive cash flow. Until interest rates get better, do not get scared if you see one more dividend cut. It will come back in time, don't you worry!

Add Fifth Street Finance to your watchlist and keep tabs on this financier to tomorrow's industry movers.

Take a recess
Market downdrafts can wreak havoc on your portfolio, but there's no reason to hide your money in the mattress. The Motley Fool has uncovered two small-cap stocks that have solid deals with the government that have the potential to deliver multibagger returns. Check out The Motley Fool's free report "Too Small to Fail: Two Small Caps the Government Won't Let Go Broke." Get access to detailed analysis of these two companies -- it's completely free.

Fool contributor Rich Duprey holds no position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of and has protective collar on AmTrust Financial Services. Motley Fool newsletter services have recommended buying shares of El Paso Pipeline Partners. 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.


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