What A Recession-Proof Stock Looks Like

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Includes: ADM, AMGN, AMNB, ARTNA, BDGE, BMTC, BMY, BRKL, BYND, CAT, CBFV, CFR, CL, CLX, CMS, CVX, CZNC, ED, ENB, ES, FLIC, HCSG, HOMB, HP, HRB, HVT, IBM, JNJ, K, KMB, KR, LTC, MED, NBTB, NTRS, ODC, OXY, PBCT, PEP, PETS, PG, SAFT, SFNC, SO, SPY, UGI, VLGEA, WABC, WEC, WEYS, WSO, XEL, XLB, XLE, XLF, XLI, XLK, XLP, XLU, XLV, XLY, XOM
by: Robert & Sam Kovacs
Summary

We believe now is a good time to prepare your portfolio for the next recession.

We also believe you can do so without sacrificing returns throughout the end of this business cycle.

In this article, we analyze what happened to strong dividend stocks in the last bear market.

Key takeaways to setting up your portfolio are proposed.

Co-written by Robert & Sam Kovacs

What does a recession proof stock look like? It is a question which more investors should be asking after a 10 year bull market. In many of our recent articles, we have highlighted that the U.S. is in the late stages of the business cycle.

We have some good news and some bad news for you.

The bad news is that we're not able to tell you when a recession will hit. Looking at all the economic indicators would suggest that recession risk in the next couple of quarters remains unlikely, as fellow Seeking Alpha author Brian Sterz points out in this article. But we can tell you that a recession will occur. This time isn't different, and this bull market will be followed by a bear market.

Market plunges take a toll emotionally on all investors, even those with the longest time horizons. Many will panic sell. Those who keep a clear head will live through it. But have no doubt, your equities will take a beating.

In a recession, you don't necessarily need to do well, you just need to make sure you're not doing as bad as everyone else.

While it is never pleasing to see your portfolio lose 10%, 20% or even 30% of its value, it is much more bearable if the market has lost even more.

Now let's move on to the good news.

The good news is that sectors which have historically beaten the market in late stages of the business cycle also beat the market throughout recessions: healthcare, utilities, consumer staples.

Source: Fidelity

This means that by reducing your exposure to certain sectors and increasing your exposure to other sectors, you can expect to do well throughout the end of the bull market and the following bear market.

This means you don't need to wait. If you wait until we're positively in a recession, it will likely be too late. Like Warren Buffett famously said "only when the tide goes out you can tell who was skinny dipping".

We already wrote an article detailing how dividend investors can use business cycle analysis to reduce risk in their portfolios and increase income. You can read it here.

In this article, we want to dive into what makes a great recession proof stock. To do so, we'll look at how well regarded dividend stocks performed during the last recession, and what we can learn from it.

Why should you even care?

Many dividend investors claim to be "buy and hold" investors, who never sell. They all chant merrily "it's not timing the market, it's time in the market". And they are half right. Time in the market is very important. Yet by refusing to sell, they refuse to take control of the weights of individual stocks in their portfolios. They also miss out on setting a sector allocation which can reduce risk and increase their income. You can read more about selling stocks to increase your income in this article.

If going into a 50% dip, you manage to limit your portfolio to loosing 30%, you'll be well positioned for the recovery. You'll be able to take advantage of relative valuations as you transition back to sectors which perform well post recession: consumer discretionary and industrials, for instance.

Look at this scenario taking two stocks: a stable utility like WEC Energy (WEC) which lost 20% of its value in the last bear market and a cyclical industrial like Caterpillar (CAT) which lost 70% of its value in the last bear market.

Both stocks yield around 3%, so let's assume they yield that amount. Let's say you have the choice between a $10,000 position in Caterpillar or a $10,000 position in WEC. Let's say you go for WEC, and in the next bear market, WEC loses 20% of its value and CAT loses 50%.

WEC now yields 3.75%, your stock is worth only $8,000. But now Caterpillar yields 6%. If you sold your shares of WEC to buy CAT, you'd lock in a capital loss which you could then use to offset future gains and while your shares of WEC yielded 3% on cost, even with the capital loss you'd increase your yield on the original $10,000 to 4.8%. A 60% increase in dividend income on the position. Plus you'd have transitioned into a sector which is now more likely to perform.

This example is very basic, and you might not get as great an opportunity or somewhat mess up the timing in real life, but even just minor tweaks to your portfolio positions could greatly increase your dividend income.

And in our book, anything that can reduce risk while increasing dividend income, is worth doing.

What happened last time around

The last recession hit stocks really hard. Between the 10th of October 2007 and the 9th of March 2009, the S&P 500 (SPY) lost 56% of its value. But not all sectors did as bad. Using the SPDR sector ETFs as proxies for sector performance, this is how each sector fared (note: Real Estate and Telecoms were excluded because the ETFs didn't trade during the period):

Ticker

Sector

10/10/2007

03/09/2009

Change %

XLP

Consumer Staples

20.56

15.48

-24.71%

XLV

Healthcare

29.54

20.13

-31.86%

XLU

Utilities

26.68

15.94

-40.25%

XLE

Energy

59.46

32.51

-45.32%

XLK

Technology

22.92

12.36

-46.07%

XLY

Consumer Discretionary

31.61

15.59

-50.68%

XLB

Materials

33.18

16.18

-51.24%

SPY

S&P 500

1561.8

683

-56.27%

XLI

Industrials

32.18

13.83

-57.02%

XLF

Financials

17.32

4.2

-75.75%

Source: mad-dividends.com

At the risk of sounding repetitive, may we point out that in any market, sector allocation will have a large impact on your returns. Much of what was to be expected occurred in the last bear market: stable, resilient sectors such as healthcare, consumer staples and utilities didn't do as bad as the market.

That's the first part of the answer to the question in the title: Recession proof stocks come from recession resilient sectors. Allocating a large part of your portfolio to industrials at this stage of the market would make no sense.

To get a complete picture we need to move on from pure sector analysis and focus on individual stocks which are relevant to dividend investors.

How did individual stocks do?

As dividend investors we are interested in high quality dividend stocks. When analyzing stocks for our portfolio we will rarely (although it can happen) consider stocks which yield less than 2.5% and which have a MAD Dividend Strength Score of less than 60 (more on MAD Dividend Scores here).

From over 3,000 U.S. stocks, of which over 1,500 pay a dividend, when screening for both a current yield greater than 2.5% and a MAD Dividend Strength Score of more than 60/100, we are left with 268 stocks. We'll refer to these as "strong dividend stocks".

Now note that in choosing to focus on these stocks, there is massive survivorship bias as we are looking at how stocks with certain criteria today fared 10 years ago.

But that's ok. Looking at this data will essentially answer: How did stocks which we are looking at do in the last bear market?

First it is worth pointing out that only 127 of those stocks 269 performed better than the S&P 500. As a group the 269 stocks, equally weighted lost 58% of their value, slightly worse than the markets loss of 56%.

We'll focus on the top 50 stocks of the group as well as the worst 50, for the period spanning the 10th of October 2007 to the 9th of March 2009.

The top 50 stocks, equally weighted lost 27% whereas the worst 50 lost 87% as a group.

The sector allocation of the top 50 stocks is as follows:

Financials

15

Consumer Staples

10

Utilities

8

Energy

6

Consumer Discretionary

4

Healthcare

3

Industrials

2

Technology

1

Real Estate

1

Source: mad-dividends.com

It is interesting to note an interesting anomaly: Although the financial sector underperformed the S&P 500 the most, 15 of the 50 stocks which performed best among our group of strong dividend stocks came from the sector. As expected, more than half of the remaining stocks are either Consumer Staples or Utilities.

Here is the sector allocation of the worst 50 strong dividend stocks

Financials

27

Consumer Discretionary

11

Real Estate

5

Materials

4

Industrials

2

Communications

1

Source: mad-dividends.com

Looking at these charts, it becomes obvious that sector allocation alone can help you a lot in making sure you don't invest in the assets which will lose the most value in a recession.

A safe thing to do at these stages of the market would be to reduce your exposure to industrials, consumer discretionary and materials, and increase your exposure towards consumer staples, utilities and healthcare.

The entire list of the 50 best strong dividend stocks in the last bear market

By now, we're sure you're curious to know which stocks made the list of top 50 stocks.

Note that these are only the best performers among the small group of 269 stocks we selected, not the entire market. Here is the list of stocks, sorted by sector.

If we have written an article on these stocks in the past 3 months, you'll be able to click on its name in the table to bring you to the article.

Ticker

Name

Sector

Div Strength Score

Div Yield (%)

Performance

UGI

UGI Corporation

Utilities

75.1

2.53

-19.46%

WEC

WEC Energy Group Inc.

Utilities

84.24

2.70

-20.96%

XEL

Xcel Energy Inc.

Utilities

63.5

2.66

-26.81%

SO

Southern Company

Utilities

72.95

4.42

-27.88%

ED

Consolidated Edison Inc.

Utilities

65.3

3.42

-31.53%

ARTNA

Artesian Resources Corporation

Utilities

60.16

2.77

-31.81%

ES

Eversource Energy

Utilities

61.29

2.79

-33.75%

CMS

CMS Energy Corporation

Utilities

65.14

2.59

-36.49%

IBM

International Business Machines Corporation

Technology

71.92

4.29

-29.43%

LTC

LTC Properties Inc.

Real Estate

70.28

4.90

-33.59%

WSO

Watsco Inc.

Industrials

68.94

3.96

-30.51%

HCSG

Healthcare Services Group Inc.

Industrials

70.74

3.27

-35.25%

AMGN

Amgen Inc.

Healthcare

79.98

3.29

-18.94%

JNJ

Johnson & Johnson

Healthcare

88.55

2.86

-29.66%

BMY

Bristol-Myers Squibb Company

Healthcare

84.7

3.61

-36.31%

FLIC

The First of Long Island Corporation

Financials

76.28

3.10

-2.73%

PBCT

People's United Financial Inc.

Financials

75.41

4.29

-3.03%

CZNC

Citizens & Northern Corp

Financials

90.25

4.24

-18.80%

CBFV

CB Financial Services Inc.

Financials

63.45

3.91

-22.49%

SAFT

Safety Insurance Group Inc.

Financials

77.1

3.23

-23.51%

BDGE

Bridge Bancorp Inc.

Financials

70.23

3.18

-25.37%

CFR

Cullen/Frost Bankers Inc.

Financials

89.68

3.02

-28.26%

SFNC

Simmons First National Corporation

Financials

92.4

2.56

-29.82%

HOMB

Home BancShares Inc.

Financials

95.33

2.65

-30.27%

NTRS

Northern Trust Corporation

Financials

90.45

2.83

-33.56%

BRKL

Brookline Bancorp Inc.

Financials

74.74

3.03

-33.97%

NBTB

NBT Bancorp Inc.

Financials

80.24

2.73

-34.08%

AMNB

American National Bankshares Inc.

Financials

78.29

3.06

-34.29%

BMTC

Bryn Mawr Bank Corporation

Financials

81.62

2.81

-35.81%

WABC

Westamerica Bancorporation

Financials

84.8

2.57

-36.09%

OXY

Occidental Petroleum Corporation

Energy

92.3

6.21

-24.68%

ENB

Enbridge Inc

Energy

63.35

8.84

-26.67%

XOM

Exxon Mobil Corporation

Energy

88.91

4.62

-30.32%

ODC

Oil-Dri Corporation Of America

Energy

63.71

2.85

-32.12%

HP

Helmerich & Payne Inc.

Energy

65.45

5.95

-36.52%

CVX

Chevron Corporation

Energy

98.87

3.83

-37.20%

VLGEA

Village Super Market

Consumer Staples

75.36

3.99

-5.16%

MED

MEDIFAST INC

Consumer Staples

85.88

2.66

-17.38%

ADM

Archer-Daniels-Midland Company

Consumer Staples

61.4

3.42

-22.96%

CL

Colgate-Palmolive Company

Consumer Staples

92.09

6.35

-24.44%

CLX

Clorox Company

Consumer Staples

73.56

2.56

-26.40%

KR

Kroger Company

Consumer Staples

69.82

2.99

-32.31%

K

Kellogg Company

Consumer Staples

76.18

3.90

-34.96%

PEP

PepsiCo Inc.

Consumer Staples

89.89

2.90

-37.43%

PG

Procter & Gamble Company

Consumer Staples

83.83

2.57

-37.84%

KMB

Kimberly-Clark Corporation

Consumer Staples

60.47

2.98

-38.01%

PETS

PetMed Express Inc.

Consumer Discretionary

76.23

6.71

-7.19%

HVT

Haverty Furniture Companies Inc.

Consumer Discretionary

72.43

3.90

-10.76%

HRB

H&R Block Inc.

Consumer Discretionary

71.71

3.74

-19.77%

WEYS

Weyco Group Inc.

Consumer Discretionary

80.08

3.58

-35.86%

It won't come as a surprise to see that among each sector, it is many household names which we find in this list.

Consumer staples such as Procter & Gamble, Kimberly Clark, Pepsico, Clorox, Archer Daniels & Colgate all make the list. If we wouldn't have screened for stocks above 2.5% current yield, other stock market favorites such as Walmart (WMT) and McDonald's (MCD) would have made the list.

Many resilient utilities appear in the list. You'll see familiar names such as Southern, WEC Energy, Xcel Energy, Consolidated Edison & CMS Energy.

We've analyzed every single one of these utilities at some point in the past three months. We recommended buying Southern and WEC, which are up 8.8% and 11% respectively since the articles were published. You can find a summary of our assessment of utilities here.

Energy stocks also see quality names such as Helmerich & Payne, Exxon and Chevron. We have written articles on both stocks in the past 3 months.

The list included only 3 healthcare stocks, but once again it is names that everyone will recognize: Johnson & Johnson, Amgen and Bristol Myers.

What do all these stocks have in common?

They are all solid blue chip names, which the investment community has come to trust. It is likely that these stocks have more long term shareholders who will hold these stocks throughout bull and bear markets. This would reduce selling pressure on these stocks, since less investors are likely to sell more speculative assets first. It is also likely that during times of turmoil, more investors seek to purchase high quality names with available cash. More often than not, they will resort to familiar stocks, a bias called familiarity heuristic. When stressed outside of our comfort zones, we naturally prefer what is familiar over what is novel.

This applies as well to stocks.

This is the second clue: In terms of turmoil, high quality large businesses get hurt less than smaller more volatile businesses.

It's back to basics. In bull markets, investors pour cash into fantasy stocks like Beyond Meat (BYND), in bear markets they most likely sell these speculative stocks and keep JNJ, XOM & PG.

Key Takeaways

Investors are always discounting their vision of the future into prices of stocks. When the crowd becomes overly pessimistic stock prices go down. Investors are less pessimistic about some sectors. These will go down less. They are also less pessimistic about certain stocks: those with large moats, large brand and name awareness and long staying power during and after the recession.

With this information at hand, an astute dividend investor would adjust weights in his portfolio to trim cyclical sectors, and remove any unproven speculative stocks.

It is important that you don't just blindly buy household names you recognize. By focusing on those with the best value and financial strength, you'll bulletproof your portfolio against the next recession.

Want to make your portfolio recession proof? Click the orange "follow" button to be notified when we next write articles analyzing safe, recession proof dividend stocks.

Disclosure: I am/we are long CAT, JNJ, WEC, SO, XOM, PG, CVX, CLX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.