How to Spot Recession-Resistant Companies

Equities markets are usually hammered during recessions as companies’ earnings take a hit from reduced consumer demand. But there are companies that do well in good times and bad. Knowing which types of companies do well even when the economy is in poor health can help shield your investment from the worst of a market downturn, and may offer the opportunity to find profit even as the broader market languishes.

How Recessions Hurt

For most companies, tough economic times mean slowing or even negative earnings growth as consumers spend less, resulting in less demand for the goods and services companies sell. This falling demand may prompt businesses to cut spending, which may impact companies from which they buy goods and services, which in turn have to cut their own costs.

In some cases, cost-cutting measures may mean layoffs, which feeds the cycle as laid-off employees have less money to spend, further crimping demand.

How to Spot a Recession-Resistant Company

Companies that provide nonessential services are typically the first to suffer in a recession. Consumers can choose to cut their own grass or paint their own houses, for example.

When looking to minimize downside risk during a recession, investors should look for companies that sell products or offer services consumers cannot easily cut. These include companies such as utilities, insurance, healthcare, consumer essentials and food. Discounters also fare well as consumers look for bargains.

Enjoys Inelastic Demand

What recession-resistant companies have in common is that the demand for their products and services is relatively inelastic: Customers have little flexibility about buying, even when budgets are tight.

Utility companies are one good example. They provide gas for heating and cooking, electricity and water. These companies generally fare well during recessions as consumers cannot easily stop consuming those services.

Their prices also do not come under pressure the way consumer products do if demand weakens, as most utility rates are set by agreement with various government agencies.

To get a sense of how this stability translates into share price, we can look at the 2008 Great Recession, when stock values took a beating. The Dow Jones Industrial Average slid more than 35% from 12,650 in early January 2008 to 8,000 one year later. It did recover somewhat by early 2010, but regained less than half its losses, crawling back to 10,000 in early January 2010.

But utilities held their value even as the market imploded. Some even made money for investors.

Pacific Gas and Electric Company (PCG), for example, was trading at about $25 in early January of 2008. One year later, while the broader market lost some 35%, PCG was trading slightly higher at just over $26 per share.

American Water Works (AWK) was similarly trading at around $21 in early 2008, climbed slightly to just below $22 by the end of the year and further still to $23 by January 2010.

These may not look like stellar performances, but given that the broader market was in steep decline, holding steady is actually an accomplishment and also shows that these companies tend to enjoy fairly stable earnings regardless of what is happening in the economy.

Provides Critical Repair Services

Companies that provide nonessential services are typically the first to suffer in a recession. Consumers can choose to cut their own grass or paint their own houses, for example.

But some service companies provide critical services that cannot be easily cut.

Waste management is one example: It takes more than a recession for people to cancel garbage collection and just let uncollected trash pile up.

So it's not surprising that shares in Waste Management Inc (WM) also held firm during the 2008 recession, and even gained ground. In early 2008, WM shares were trading at about $29, but then climbed to nearly $34 by the end of the year even as the market lost over a third of its value.

Auto repair and parts companies are another example: Consumers generally have no choice to repair their cars if they break down, even if financially challenging.

AutoZone, Inc. (AZO) also fared well during the 2008 recession. The company's share price was around $120 in early January, 2008, before the recession hit in earnest. One year later, it had climbed to $132, and then further to $155 by January of 2010-the height of the economic crisis.

Sells Proprietary or Specialized Products

Pharmaceutical and healthcare companies with drug patents also enjoy relatively inelastic demand for their products. Consumer buying habits remain stable regardless of price, especially if the product is something they have to buy.

Insulin is a good example. Diabetics who need insulin to survive have no choice but to pay, whatever the cost.

Indeed, the S&P Pharmaceuticals Select Industry Index did take a hit at the onset of the 2008 crisis, slipping just 8% from 1,660 in early January 2008 to 1,530 one year later, but by January of 2010 the index had not only recovered but jumped to over 1,900.

Sells Discounted Products

In tough economic times, discounters also do better as people look for bargains.

Before the 2008 recession, Dollar Tree Inc (DLTR) was trading at $9.24, but by January of 2009 its share price had climbed some 54% to $14.24, and a further 16.5% to $16.50 by January of 2010.

The Bottom Line

While most companies are negatively impacted by recessions as consumers cut spending, there are companies that weather tough times better than others. Consumers can easily cut spending in many areas, but there are some things consumers cannot easily eliminate from their budgets.

Companies that provide goods and services people need or which are medically or legally required tend to do well regardless of economic conditions. These include utilities (as people still need to heat and power their homes), insurance (car insurance, for example, is required) and healthcare (such as insulin: a diabetic cannot simply stop taking it even if the price creates financial hardship). These companies offer a safe haven to shield investors from the worst of a downturn, and may even offer positive returns.