As many financial experts and CEOs forecast a full-blown economic downturn in the not-too-distant future, spurred by tighter monetary policy from central banks, I think it's a good idea for investors to find ways to protect their portfolios in this type of potential scenario. This will provide much-needed peace of mind in tough times.
With that being said, stocks and companies that are recession-proof have one important characteristic in common that investors should know. Let's take a closer look at an apt example to provide more clarity.
Demand remains resilient
I believe the No. 1 sign of a stock that is recession-proof is that demand for the products and services that the business sells remains strong in an adverse economic situation. From a customer's perspective, this means they simply cannot go without the items that the company offers no matter what the economy is doing. In fact, demand stays stable or might even increase.
O'Reilly Automotive (ORLY -1.41%) is the perfect example of a business that not only survives recessions, but can even thrive in them. As one of the leading automotive aftermarket parts retailers in the U.S., with trailing-12-month revenue of $14.1 billion and over 5,900 stores, O'Reilly offers both DIY and professional customers products like brakes, batteries, motor oil, and the like to help fix up automobiles.
In a strong economy with low unemployment, people drive more, increasing the wear and tear on their vehicles. And this results in higher demand for O'Reilly. Over the past decade, from 2011 through 2021, sales rose at a compound annual growth rate of 8.7%. And during this stretch of time, gross margin and operating margin -- and therefore profitability -- showed drastic improvement.
In a recession, on the other hand, instead of looking to buy new cars, consumers will be inclined to extend the lives of their existing automobiles. And again, this leads to strong demand for O'Reilly's business. In 2009, during the Great Recession, revenue jumped 35.5%. That same year, the company generated profit of $307.5 million.
And CEO Greg Johnson remains incredibly optimistic as we face a looming recession in 2023.
"We expect for demand in our industry to remain resilient as consumers who are facing high inflation and economic uncertainty prioritize the maintenance of their existing vehicles in order to avoid taking on a payment for a higher price on a newer vehicle," he said on the latest earnings call.
The opposite of a recession-proof stock like O'Reilly Automotive is a cyclical business that puts up strong financial results when the economy is booming, only to face major difficulties when things take a turn for the worse. Plus, these companies will see their financials deteriorate, with falling profitability.
Consumer discretionary stocks, like certain retailers, hotel companies, airlines, and apparel businesses, fit the description here. While they may certainly perform well in a positive economic backdrop, they aren't a smart place to park your money when a recession appears likely.
Protect your portfolio
With the Federal Reserve continuing its pace of hiking interest rates in order to curb soaring inflation, many financial and economic experts are calling for a recession to happen sometime in 2023. With this context in mind, investors who want to protect their portfolios in the event of an adverse macroeconomic backdrop should probably consider buying shares of O'Reilly Automotive today.
Not only has this business proven that it can be successful in good times, but it is also a stock you'll definitely want to own in an economy like the one we're in today.
