There's no such thing as a risk-free stock, but some businesses are better equipped to handle recessions than others. In recessions, some types of businesses are more likely to remain profitable and even keep growing, no matter how bad the economy gets.
Here are five things to look for when assessing a company's ability to weather an economic storm. If a stock you're looking at meets all or most of these criteria, you might have a recession-proof stock (or as close to it as you can get).
1. The business sells things people need
Not allrecession-proof businesses fall into this category, but the vast majority do. Recession-proof businesses sell things people need, as opposed to things people (or businesses) want.
Here are a few examples. Utilities like Dominion Energy(NYSE: D) provide services people need, no matter how bad the economy gets. The same can be said for auto insurance companies like Progressive (NYSE: PGR). Drugstores like CVS Health(NYSE: CVS) not only sell things people need, but also provide them in a timely manner.
2. Pricing power
Businesses that have exceptional pricing power tend to have higher consumer demand (especially for discretionary products), and also tend to have better margins than their competitors. Brand strength allows Coca-Cola(NYSE: KO) to charge more for its products than competing brands, for example. Apple(NASDAQ: AAPL) has an extremely loyal customer base that allows it to increase prices with little affect on demand.
3. A market with few big players
It's tough to find true monopolies (outside of utilities), but businesses that have only one or two major players in their industry tend to perform very well during tough times. Visa(NYSE: V) and Mastercard(NYSE: MA) are excellent examples. The two have an effective duopoly on payment processing in the U.S. and get a percentage every time someone swipes one of their cards.
4. Profitability and earnings growth, no matter what
Recession-proof businesses make money, no matter what. Utilities are a good example. Discount retailers are another category that can be recession-proof and can even gain sales during bad times.
Take Walmart(NYSE: WMT), for example. When the U.S. financial system was on the brink of collapse in 2008, Walmart had one of its best years ever.
A strong balance sheet also ties into this. It's difficult to turn a profit in bad times if your company is drowning in debt, but a low leverage ratio combined with lots of cash on the balance sheet can be almost as important to recession resistance as the business itself.
5. Long-term tailwinds
Finally, there are some trends that are more powerful than any recession. E-commerce is a great example. Just 15% of U.S. retail sales currently come from e-commerce, and this has been steadily growing for years. Even if a recession comes, e-commerce companies that meet some of the other criteria on this list are likely to be just fine in the long run.
Recession-proof doesn't mean risk-free
One important distinction to make is that just because a stock is recession-resistant or recession-proof doesn't necessarily mean it's risk-free or even low risk. For one thing, stock prices fluctuate significantly over time, and it's not uncommon for even the most stable companies to decline by 25% or more in a bear market for reasons having little to do with the underlying businesses.
Some recession-resistant businesses rely on borrowed money (especially true with real estate stocks) and are vulnerable to higher borrowing costs. Many essential businesses have competition risk and regulatory risk, and many could be disrupted by e-commerce.
The point is that recession-resistant stocks aren't guaranteed winners. It's still important to evaluate the entire business before investing and be prepared for market fluctuations.
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Matthew Frankel, CFP® has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, Mastercard, Visa, and Walmart Inc. The Motley Fool recommends CVS Health, CVS Health Corporation, Dominion Energy, Inc, and Progressive and recommends the following options: long January 2024 $47.50 calls on Coca-Cola, long March 2023 $120 calls on Apple, and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.