Investing in the Face of Obama's Budget

Nate is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

For the first time in a long time, there's a small ray of hope over the federal budget.

It's a small one, to be sure, but it's there. There is an actual prospect that a federal budget might be passed and it might represent a compromised between entrenched interests on both sides of the aisle. A year ago I would not have put any faith in that sort of thing happening.

Budgets are for wimps!

The American federal budget is a sore point for many people. Not having a reliable one means that the president needs to rule by executive order and has to stick with scheduled increases instead of having the flexibility to deal with issues and adjust priorities. Congress gets to make noise about wanting a balanced budget and cutbacks without actually having to specify cuts. It's a mess.

But with some actual movement – no matter how unlikely it may be to actually occur – there's a solid reason for investors to start thinking about the impact of a new budget on the markets. With entitlement cuts in the budget through the proposed chained consumer price index (CPI) plan, disposable income will be decreasing for some people. That can impact the sales of certain goods and services -- and even equities.

Who's gonna win?

First up, a smaller, trimmer federal budget doesn't mean that the federal government spends less money. In budget-speak, it means that the growth in spending slows while the total amount keeps rising. Wonderful, right? Still, it does mean that those receiving anything tied to the CPI will receive less in their monthly checks.

Here's a few stocks that should do well with less income in some pockets.

Costco (NASDAQ: COST) will do well with fewer disposable dollars running around. A true discount retailer, Costco provides cheap goods in a convenient location. As seniors and those on disability find themselves with marginally less income (though it adds up over time), the pressure to save money by moving from more upscale stores to low cost stores will begin to add up.

Costco is already on the way up, even in the face of a growing economy. Just released sales numbers for March show a 7% growth in year-over-year sales and the company's shares have reflected it, outstripping the Dow and growing 19.57% over the last twelve months.

Another one that should thrive is McDonalds (NYSE: MCD). The chain isn't famous for giving you healthy meals, but it is possible to eat there cheaply. The company has had a few bits of bad news over the last six months with soft year-over-year sales numbers, but international expansion continues to make it profitable with a 19.82% net margin in 2012. Shares have only grown 3% over the last year, though that hides the fact that they've grown 11.17% in the last three months, finally outpacing the market as a whole. A 3.02% dividend yield is handy as well.

Who's gonna lose?

A smaller amount of disposable income is going to be rough on companies that sell things people want but don't need. Over the long term, the removal of a small piece of income from a lot of wallets will damage spending on luxury items.

Like, say, Apple (NASDAQ: AAPL). Apple makes great products, but they're pricey. Even with the hints of a cheaper iPhone, cutting back on spendable cash will cut off some of the demand for the company's products. I don't think it will tank Apple's sales completely, or its share price. The company remains insanely profitable and poised for a real resurgence after its shares tanked late last year, but the growth will be lower than one might otherwise expect.  It is not a crime -- regardless of what the yammering class thinks -- to have an operating margin that's only 31.57% or to have a EPS of only 44.10.  Most other firms would love to see that, but they're not Apple, so they're not held to an insane standard.

Amazon (NASDAQ: AMZN) is another one that is vulnerable to a cut in discretionary income. The company already operates on a razor thin margin – last year's net margin was 0.19% – and anything that keeps people from spending will create a real challenge for Amazon. I've never been convinced that Amazon has a long-term plan to achieve a decent level of profitability in the first place and this won't help.  Amazon is the flip side of the Apple phenomenon -- the company is held to an enormously forgiving standard.  Any other firm that reported a -0.09 EPS and a 2012 operating margin of 1.11% would have seen its stock tank hugely.  Instead, people seem to love it without reason.

Moving on

The safest bet is that the fight between Republicans and the President continues, and we will find ourselves without a new budget. But on the off chance that they do find common ground and entitlement spending is cut through a chained CPI plan, investors should be aware that the economy will find itself with a small, but very long term weight on its ankles. It won't slow it down a lot, but the effects will pile up. A smart investor plans for such things.


Nate Wooley has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Apple, Costco Wholesale, and McDonald's. The Motley Fool owns shares of Amazon.com, Apple, Costco Wholesale, and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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