Judging by the preponderance of gloomy market headlines over the past two weeks, stocks are ready for the big flush down the commode. The fear of deflation has passed us by, and consumer and wholesale prices are inching upward, despite our government's best efforts to hide that fact by excluding inconvenient data, like soaring gas and housing costs.
Wall Street is watching Alan Greenspan like a mouse eyeballing an eagle, scurrying from mini-rally to mini-rally and waiting for any sign to head underground for a while. A rate hike is on the way, that much is certain. As soon as it happens -- the Brill Cream-and-starched collar crowd tells us -- all stock prices will fall. It always happens that way.
For the record, I don't believe a word of it. Like my esteemed and excellently snarky colleague Bill Mann, I've got plenty of contempt for the chattering class that aims to pass off broad Economics 101 theory as an informed prediction of our collective financial future. If you're too lazy to click that link and see what he had to say, here it is in a nutshell: In the real world, theoretical truths hold about as much water as my favorite pasta strainer.
But here's the beautiful part. Even if one of these predictions does hold, it doesn't have to wreck your portfolio. You don't have to invest in the whole market; you can pick companies that are likely to swim against the tide.
Readying the bunker
Just because I don't believe the predictions of disaster doesn't mean I ignore them altogether. Hey, I am also pretty sure that my house is not going to burn down, but I carry insurance against the possibility. Bill and I have a running, and only somewhat amusing, gag of responding to worries about impending financial disasters by figuring out what kind of stuff to stock in our imaginary backyard bunkers. Usually, the joke is limited to selections for ammo, rations, and whether to stuff the mattresses with dollars, euro, or gold.
In reality, I don't think the economic outlook demands an all-, or even mostly, cash position. After all, if things don't go badly, you'll be making next to nothing on your nest egg, even if you eschew the mattress in favor of a CD or money market account. But as individual investors, it's in our best interests to consider what kind of stocks we might want to keep in our arsenal, to lock up with us in order to weather any upcoming storms.
My own suspicion is that there will be some pretty jarring economic shocks in the years ahead, but that they will be relatively short-lived. So, I tried to figure out what kind of companies would be best positioned to get over these bumps with the least damage.
What to pack
These days, I can't seem to step away from the stock screeners, so I used these handy tools to search for companies with the following survivalist characteristics:
1. Size: Not too small, not too big. Let's go with a tree analogy. I wanted to find companies that were large enough to survive any big windstorms, but small enough to have ample room to grow. Can you say mid-caps? Market capitalization between $2 billion and $5 billion means you fit through the armored door.
2. Cash: Lots of it. Cash is the best protection against short-term problems. An ample war chest can fund substantial restructuring or simply allow a firm to tread water for a few quarters if sales take a turn for the worst. Thirty million dollars in cash gets you an entry ticket and all the Spam you can eat.
3. Debt: None. OK, almost none. Debt is a real killer when things go bad. You can lay off workers or shut down a plant much more easily than you can convince your bankers to stop requesting interest payments. And companies that rely on debt are going to have significant increases in interest payouts once rate hikes kick in. Anyone with under $1 million in long-term debt can get a cot next to the exhaust fan.
4. Free cash flow: The next best thing to a big pile of cash is the ability to generate more cash, and quickly. (When times are good, the FCF might even be more important than the stockpile.) If you can provide $60 million in unencumbered cash, you can have my bunk and fluffy blanket.
5. Results: Hey, cash and earnings are great, but if they don't do anything for us shareholders, what's the point? There are really only two good ways to use the corporation's dough, and they are not fancy shower curtains and cheesy birthday parties in Sicily. Suitable uses are expanding the business profitably -- i.e., they have good returns on equity (ROE) -- or sending it to investors via dividends or well-timed stock buybacks.
The bunker tribe
It's been a grueling and unforgiving selection process, but the weak head home crying, and the following stocks make it into the bunker:
QLogic (NASDAQ:QLGC) is a maker of computer and storage network infrastructure components such as fibre channel switches and drive controller chips. At the end of last month, the company was slammed when it reiterated lower earnings guidance and investors seemed edgy about the reality of the expected tech rebound. Share prices have been cut in half since last November. While it isn't growing at the 25% clip that some expect for a tech firm, it's tough not to be intrigued with its $742 million war chest and the $135 million in free cash flow turned in for fiscal 2004, reported yesterday.
Garmin (NASDAQ:GRMN) is another tech company that's taken a beating over the past few months, and it was further clobbered this week after reporting first-quarter earnings that jilted an especially brittle investing public. A slip in margins gets the blame for causing the panic, but from my seat, this is an even more compelling firm. The name is now synonymous with global positioning navigation, and sales are still growing near 30%. It also has an astounding ROE of 26%, pays a dividend, and is repurchasing shares at the recent bargain prices. Garmin is not only welcome in my bunker; I'll sing it to sleep and do its share of the chores.
Quick-growing Chico's FAS (NYSE:CHS) is a longtime Fool favorite, and it makes it into the bunker despite having the smallest cash hoard of the bunch. The reason? It's a complete steamroller. Comps increases of 20% are not unusual for this premium retailer of women's togs, and sales and earnings growth north of 50% is par for the course. Of course, you pay through the nose for this kind of performance, but people who've been waiting for a cheaper entry to Chico's have rarely been rewarded for their patience.
Abercrombie & Fitch (NYSE:ANF) has taken some heat at the Fool for what some -- including yours truly -- have seen as a shortsighted emphasis on off-color marketing. Still, there are signs of a cleanup even amid a slight cool-off for the firm's sales. With a well-known brand, terrific ROE of 27%, and a dividend, Abercrombie is welcome to join us in the underground. But watch it, buster, I've got my eye on you.
The final ticket to our lovely concrete abode goes to Synopsys (NASDAQ:SNPS). The company basically facilitates the design of circuits and chips through software and services. In other words, it sells the stuff that allows chip designers like NVIDIA (NASDAQ:NVDA) to move technology ahead. A recent pricey and failed acquisition -- that had one Fool scratching his head -- notwithstanding, the firm has interesting prospects and a bargain enterprise value-to-free cash flow ratio just above 10.
The bottom line
Here's a little secret for you from a former newspaper journalist: There has to be a headline. That's right, even when there's nothing to say, something's got to be said. That's why you wake up ever day to nonsensical predictions on Yahoo! (NASDAQ:YHOO) Finance like "Market Set for Lower Opening," replaced within minutes by gems like "Markets turn higher."
But the truth is, nobody's got a working crystal ball. Sure, the economy could head south, and the market could follow. And you can bet that if that happens, there will be jubilant "I told you sos" and an equal measure of silence from the pundits who said it couldn't happen.
But there are always means of surviving the storms, and the best method is to do your homework and invest in great companies that are doing things right. Take a few to the shelter now and then, but don't hide in the bunker alone. The biggest risk in investing is taking no risk at all.
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Fool contributor Seth Jayson enjoys wearing camo, taking part in the occasional combat shooting contest, and talking conspiracies. He has no stake in any firms mentioned above. View his Fool profile here.
