A recession or a depression is not uniformly bad to everyone. There are a lot of companies that can benefit from the current market condition if their business models are good and have enough cash to not rely on the debt markets. There are certain industries that will be created or be greatly benefited as consumers shift their choices and lifestyles. During the Great Depression, for example, the nascent movie industry greatly benefited as more unemployed folks paid a nickel to watch a movie and spend 3 hours of their time. Then there are strong companies in weak markets where the recession helps in killing the weaker competitors and giving the strong ones a greater share of the market pie. They can also afford to give their employees lesser salary and bargain hard with their suppliers. Then there are companies that offer an inferior good (in an economic sense) that can be substituted for a superior good. Those who would normally buy at Nordstrom (JWN) or Macy's (M) might move to Wal-Mart (WMT) or Amazon.com (AMZN), for example.
In looking at the prospective companies, we should not just see market share, but also look at their profitability and balance sheets, because even increasing revenues cannot help if the companies run operating losses or are way deep in debt. Electronic Arts (ERTS) is an example where increasing revenues and users have not brought profits. Here we look at companies that might benefit from the depression/deep recession ahead of us and also have sufficiently comfortable financial position to carry them through.
The Wall Street Journal reports about the increasing usage of online games and movies among those who are out of work. According to Comscore data, the leisure minutes spend on the Internet jumped up almost 20% last year. A lot of these people spend time in online games, where the number of visits went up 27% last year according to the report from edge-online.
Not all companies in gaming are profitable, however. The market leader, Electronic Arts (ERTS) is losing money and cutting jobs.
Companies to look for in this space:
- GigaMedia (GIGM) is making games targeting Chinese audience and has no debt, gross profit margins above 60%, a P/E around 8 and PEG of 0.46.
- Activision Blizzard (ATVI), makers of Guitar Hero nd other popular games, with very good growth, lot of cash and good profit. Its P/E is a bit high, but it is selling at its book value and profit and revenue growth is pretty attractive.
If you have a whole day off, don't have money to go to vacation or parties, and you want to forget the sorrow, what would you do? If you are like most people, you will watch movies and TV. And the movie industry will grow to meet increasing demand. The times of sorrow produce great ideas and inspiration for the movie producers. The Great Depression was a great time for the movies and many of my personal favorites including – Gone with the Wind, Wizard of Oz, It's a wonderful life, City of Lights, and A Night at the Opera came out in 1930s. Theatres are already reporting a spurt in growth and production companies should also benefit.
However, that might slow down at some point as people might not be able to afford the $10/per person tickets along with $5 for travel and food. A typical family needs to spend over $50/visit to the theatre, and that might be unaffordable for some. Here comes streaming and home video. NetFlix (NFLX) will become a even better choice as it costs less than $15 for a month worth of entertainment for an entire household. The customer growth and profit growth have been terrific for them, and around 10 million homes in US use them. The stock has been on a terrific run (see its comparison with S&P 500 in the chart below), has no debt and is gaining market share on its bigger rival Blockbuster (BBI) (though I'm personally still holding on to BBI as its store service is good). The only concern is its P/E is in the 20s, as compared to its competitor BBI which is around 4 and has fallen 60% last year. So, there is some probability that it might be a bit overvalued right now and might not attract Value investors. But, if the profit grows like how it did last quarter (90% yoy growth in profits) then P/E should not be too much of an issue.
Even the unemployed have to eat and bathe. So stores selling groceries and other essentials should not be too affected. Moreover, when people stop buying clothes at Nordstrom or JC Penney (JCP), they will have to switch to some discount retailer. Here is where Wal-Mart comes in. It is a well-run company and has both the cash and the capability to survive long. It can also squeeze its suppliers in this deflationary phase. The stock has fallen off 15% since its peak in September 2008, but it is still holding good and has far outperformed both its competitor Target (TGT) and the overall market. It has a lot of cash (about 6 billion), possesses great cashflow, and has a fairly attractive P/E of around 13.
Another company that is profiting here is Amazon (AMZN). It has a $2 billion+ cash chest and its revenues are growing. Layoffs would produce a lot of workers who would want to upgrade/polish their skills with new books or spend more time with other books they always wished to read. Reading is an inexpensive hobby and can survive a depression. Given that online shopping is more cheaper and online time spent per person is increasing, its sales are growing. In fact, its sales surged 18% and profits by 9% last quarter. Its high P/E will be a cause of concern to value investors.
Pharmaceuticals and Consumer Goods
A recession doesn't mean people don't get sick or stop brushing their teeth. It is very hard to avoid Johnson & Johnson (JNJ) and Procter & Gamble's (PG) products in daily life and there are companies that have been there forever (overcoming depression and other economic crisis over 100 years). These are also very good in dividends and help the good old fashioned investors. JNJ is much more cash rich than PG ($12b vs $4b) and has lower P/E, but PG is still growing good in revenues, while JNJ has a slightly negative revenue growth last quarter. So, if you are a growth investor, choose PG, and if you are value, choose JNJ. Merck (MRK) is another choice that readers should research more.
A recession or depression might produce more sin than prosperous times. Take a look at tobacco companies like Altria group (MO) (owners of Phillip Morris) and British American Tobacco (BTI). MO has very little debt and an attractive P/E (~5) compared to BTI, which has a net debt over 10b and a P/E of 16. However, MO's growth of around 6% (last quarter) is far outpaced by BTI's 25% growth last quarter. Liquor company Pernod Richard (RI) is another firm the readers should research more.
Disclosure: I have no positions in the stock discussed here - GIGM, ATVI, NFLX, WMT, AMZN, JNJ, PG, MRK, MO, BTI, RI.