As an optimistic person, I usually don't bother reading the commentary of doom-and-gloom analysts who predict darker times while they ring the death knell for the markets. Nevertheless, no prudent investor should be blind to the prospect of a serious market correction. With our uncertain geopolitical future, the ever-present threat of terrorist actions, soaring oil prices, and a more restrictive monetary policy, who knows when the next precipitous market decline might come?
When it does, where can equity investors seek shelter -- aside from cash and bonds? Screening can narrow the field by weeding out firms that won't measure up in a down market. Among those that do make the grade, screens can thin the pool further by pinpointing those candidates most likely to swim when others around them are sinking. Which traits will best serve as life vests for these sorts of stocks?
Performance: For a variety of reasons, some companies aren't very highly correlated to the market and tend to zig when other stocks zag. While these stocks usually lag in a strong market, they often emerge as leaders in a weak one. Knowing how a stock reacted to the last bear market may provide insight into its behavior during the next one.
Yield: In a rising market, investors often overlook relatively paltry 2% to 3% dividend yields as they hunt for bigger game. Let's not forget, though, that dividends represent 42% of the Standard & Poor's 500's total return since 1926. Whenever stocks tumble, these payments will help cushion the fall.
Valuation: It may be cliche to assume that higher priced stocks have further to fall, but trite sayings are often grounded in truth. In tough times, bargain-priced stocks should hold up better than their racier cousins. With that in mind, companies trading at excessive valuations should be avoided.
Profit margins: Earnings -- still a driver of stock prices, though we at the Fool often endorse free cash flows -- are essentially a function of two things: sales and margins. In an economic slump, flagging revenues may be inevitable, making margins the last line of defense. All things being equal, a company with higher margins will be better equipped to keep an even keel in rough waters.
Balance sheet: There is nothing inherently wrong with debt, provided it is deployed judiciously. Leverage can be a problem, though, when cash flows become insufficient to meet obligations. Companies saddled with mountains of debt and weak interest coverage may have dug holes too deep to climb out of in a troubled economy.
Beta: Beta is a core measure of a stock's volatility compared with the broader S&P 500 -- which by definition has a beta of 1.0. High-beta stocks have more sensitivity to market fluctuations, while low-beta stocks typically exhibit smaller price swings. A stock with a beta of 1.5, for example, tends to rise 50% more than the S&P during a rising market and fall 50% harder when the market is dropping. By itself, beta can be a misleading statistic, but it can be a useful gauge in conjunction with other factors. I looked for below-average betas.
Beyond the numbers
Targeting companies that scored well in the areas above helped reduce the stock universe down to a workable group, but there is another important element in the process. Computers (at least not mine) cannot think or interpret the data, so rather than rely exclusively on screening, I tempered the process with a little common sense, intuitive judgment, and top-down analysis. In other words, I made another round of cuts based on qualitative factors (i.e., which industries will be least affected by a sluggish economy). The end result closely resembles the methodology used to determine which teams compete for NCAA football's Bowl Championship Series (BCS) trophy -- part computer, part human, lots of guesswork.
And the winners are:
|Ticker||2001 return||2002 return||Yield||Price/earnings (TTM)||Operating margins (TTM)||Interest coverage||Beta|
(1) Anheuser-Busch (NYSE: BUD ) . The St. Louis-based brewer maintains a 50% stranglehold on the domestic beer market, and while volumes aren't growing much, they aren't likely to shrink either. The company has made strategic advances in the fast-growing Chinese market and is enjoying strong pricing power domestically. The King of Beers has also posted 23 consecutive quarters of double-digit earnings growth and raised dividends for 28 straight years. The bottom line: A tough economy is unlikely to quench the nation's thirst for beer.
(2) Bank of America (NYSE: BAC ) . After the acquisition of FleetBoston, Bank of America became the nation's third-largest financial institution and the first true coast-to-coast retail banking operation. The merger gives the combined company 5,800 branches (80% more than the nearest rival) and is expected to yield over $1 billion in cost savings. The company has a broad reach, both operationally and geographically, but the bank's crown jewel is the flourishing consumer banking division. With 33 million consumer accounts and $1.1 trillion in assets, this financial powerhouse has the strength and diversity to fend off a bear attack.
(3) Moody's (NYSE: MCO ) . We are a highly leveraged society, and if there's a protracted economic downturn, we may need even more debt to operate. Credit ratings agencies grease the wheels of the capital markets, and thanks to stringent government regulations, Moody's competes with only a small handful of rivals in the lucrative business. With low capital requirements, the company maintains enviable operating margins north of 55% and wrings substantial profits out of its sales, which are expected to grow by double digits this year. The Motley Fool Stock Advisor pick is also shareholder-friendly and has repurchased over $1 billion in company stock over the past several years.
(4) Procter & Gamble (NYSE: PG ) . This Dow Jones Industrial Average component is the world's largest consumer products company, with over 300 global brands (16 of which deliver $1 billion in annual sales each). P&G sells $50 billion of everyday household products (think Tide, Pampers, and Pringles) annually, and has generated more than $7.5 billion in free cash flow over the past 12 months. With strong brand awareness and loyalty for essential day-to-day products like toothpaste, shampoo, and laundry detergent, this geographically diverse 170-year-old company has weathered many storms, and should stay afloat in even the choppiest of markets.
(5) Sysco (NYSE: SYY ) . Sysco is a giant in the food distribution business, with a greater market cap than its 10 closest competitors combined. The Houston-based company supplies more than 400,000 restaurants, hotels, schools, and hospitals with food. Thanks to economies of scale, it also enjoys some of the highest margins in the industry. To a certain extent, food is largely recession-proof, as evidenced by Sysco's 28 consecutive years of record sales and earnings.
(6) Waste Management (NYSE: WMI ) . Rain or shine, we take our trash to the street each week, and someone has to haul it away. Waste Management is the leading trash collector, with 27 million commercial, industrial, and residential customers along with 40% of the nation's disposal capacity. Like most companies on the list, Waste Management has few rivals with which to contend. Government permits for landfills are as good as gold, and Waste Management operates around 300 -- twice as many as the nearest competitor. Both volume and pricing have risen lately, enabling the company to raise dividends and announce a $500 million stock repurchase program.
The common denominator
These blue-chip companies all operate in consistent, stable, and mature industries, and most represent the dominant force in those industries. During the tumultuous years of 2001 and 2002, when most companies were looking for a place to hide, this group posted solid gains. This list is by no means all-inclusive, but I'd say each of these stalwart companies stands a better than average chance of holding its ground when the next bear is on the prowl.
What do Ben Graham, Bill Miller, and Warren Buffett have in common? They are all value investors. You can be too -- take a free trial of theMotley Fool Inside Valuenewsletter.