With the stock market nearly all the way back to where it started the year, some may think the rally of the last few months may be running out of steam. While I'm not sure that's the case -- it's virtually impossible to predict the near-term movements of the markets -- there are any number of ways stocks could be primed for another downturn, especially if a second wave of COVID-19 affects the economy.
But even if you're fearful of another market downturn, it still shouldn't deter you from sticking to your long-term investing plan. If you're putting new money to work today, or reallocating from "out-of-home" stocks after their recent rally, here are the three types of safe stocks you should be looking at to protect the downside in your portfolio.
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Cash-cow stocks
Looking for rock-star stocks that can power through a downturn? The search for prime recession-resistant stocks shouldn't necessarily start with the income statement, where revenue and profits are recorded, but rather the balance sheet, where a company's assets are matched up against its liabilities.
Companies with lots of cash and little or no debt are a great place to start recession-resistant investing. That's because a healthy balance sheet allows companies to continue operating during a cash crunch, without having to raise capital -- often expensively -- or even worse, declare bankruptcy.
But the advantages of a solid balance sheet go even further than that. Oftentimes, a recession or depression allows cash-rich companies with strong balance sheets to acquire assets or entire companies at big discounts, and these recession buys can often pay off big years down the road. Doubling down on internal investments as cash-strapped competitors struggle could also lead to market share gains.
Finally, a healthy balance sheet is often not necessarily the cause but the result of a great business in general. As they say, "success leaves clues," and if a company has lots of cash to work with, it likely has a winning business model that can mint high profits with great returns on capital.
A good example of a cash-cow stock is Google parent company Alphabet (GOOG -1.10%) (GOOGL -1.23%), which had a whopping $117 billion of cash on its balance sheet against only $5 billion in debt as of last quarter. While Alphabet's core digital advertising business is taking a hit amid the recession, the company should remain profitable, all while being able to continue investing in newer initiatives such as cloud computing and even stepping up repurchases of its own stock.
Another example is Warren Buffett conglomerate Berkshire Hathaway (BRK.A 1.18%) (BRK.B 1.30%), which had about $133 billion in cash against just $37.5 billion in debt last quarter (outside of the $66 billion in non-recourse debt against its energy, railroad, and utility assets). The famously conservative Berkshire has been hesitant to invest in this downturn, and has missed much of the subsequent rally. However, should another market or economic downturn aftershock hit, shareholders will be glad that Berkshire has such a large cash cushion to deploy in the company's trademark patient, risk-off manner.
Recurring-revenue stocks
In addition to cash cow stocks, another type of company likely to withstand a recession are recurring-revenue stocks. Recurring revenue occurs when customers pay for a necessary service month after month, instead of one large payment every so often. This model often works for businesses such as software-as-a-service, streaming video, broadband, and utilities. Incidentally, these necessary services are also likely to be least-affected by coronavirus, and are thus doubly compelling today.
One powerful type of recurring revenue is the subscription model, in which companies often charge for an entire year upfront, giving their management teams clear visibility for the year ahead to plan accordingly. There are lots of compelling software-as-a-service stocks in the emerging cloud enterprise software sector today. These include financial and human capital management software company Workday (WDAY -1.34%), database disruptor MongoDB (MDB -2.41%), cybersecurity software company CrowdStrike (CRWD -3.90%), or the larger customer relationship management giant Salesforce.com (CRM -0.57%). Each of these stocks has already made back, or even exceeded, their prices at the beginning of the year, because of their steady and predictable revenue streams from enterprise clients that need them to run their businesses.
Other recurring revenue businesses might include your monthly broadband subscription, which may go to a Charter Communications (CHTR 2.04%) or Comcast (CMCSA 1.57%). The same goes for top utility stocks, which deliver necessary water and power to homes and businesses. Utilities often pay attractive dividends, which look very good in a low-interest rate world. Examples of top utilities include NextEra Energy (NEE 0.45%) or Duke Energy (D 2.62%).
Food and health stocks
Both broadband and utility stocks also double as necessary goods and services, which people still need to buy in order to stay alive and well amid nationwide quarantines, recession or not. And first among the hierarchy of needs are food and healthcare. Top companies that deliver these essential goods and services should hold up just fine in another economic downturn.
Should a recession hit, access to groceries will remain key, which should keep the dividend-paying grocery stocks like Kroger (KR 1.80%) and Walmart (WMT 0.46%) afloat. Both companies have also been investing heavily in their digital capabilities in recent years, allowing customers to receive delivery or curbside pickup in many locations. In case of a second wave and economic downturn, people aren't going to stop eating, so staying home from restaurants will necessitate more grocery-buying, benefiting these two consumer staples retailers.
Like food, people also can't afford to put off buying necessary medical treatments and drugs for their ailments. That should put a floor under many healthcare stocks -- especially as health concerns come to the forefront in these times. Two Fool favorites in the healthcare space to put on your list are Vertex Pharmaceuticals (VRTX 0.20%) and Teledoc Health (TDOC -1.52%).
Vertex Pharmaceuticals is a specialist in genetic diseases, and currently has a monopoly on its best-in-class treatment for cystic fibrosis, Trikafta. Trikafta just had its first full quarter of U.S. sales, and is set for European approval later this year, which should power growth for the rest of the year and beyond. Vertex is also investing in its pipeline for other genetic diseases as well, such as alpha-1 antitrypsin deficiency (AATD), and APOL1-mediated kidney disease.
Meanwhile, Teladoc Health's stock has exploded this year, helped by the increasing need for remote health services, as people continue to adopt tele-medicine for all but the most serious problems, since going into a hospital poses risks amid COVID-19. Teladoc's valuation is very high today, as investors have jumped on the tele-medicine train, but in case of a second wave and recession, Teladoc is primed to benefit from the increasing need for remote health. In a COVID-induced recession, Teladoc is potent combination of healthcare and stay-at-home digital innovation, making it a good candidate to weather another COVID-19-inspired downturn.
Know what you're buying
Cash-cow stocks, recurring-revenue stocks, and necessary goods and services stocks all have significant cushions against recession, either through a strong balance sheet, predictable revenue, or counter-cyclical elements in their products and services.
Whether or not the economy opens up this summer or a second wave hits, these three types of stocks are good candidates to at least maintain their financial strength and your investment principal along with it -- even should the worst occur.
