Recession-Proof Your Portfolio

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

It is becoming clear that the Federal Reserve cannot continue to artificially prop up asset prices in a terrible economic environment. The data suggest that the U.S. could be headed for another recession in the coming quarters. Therefore, investors would be wise to recession-proof their portfolios.

Some companies are better at weathering downturns than others because their products either are critical to the functioning of their customers or cater to price-conscious consumers. Companies that are critical to their customers tend to operate in industries such as healthcare services. Others, like Wal-Mart, benefit when a greater portion of the population becomes more price conscious when they otherwise would prefer higher quality. The first company discussed in this article fits the latter category, while the other two fit the former.

Low-priced auto parts

Advance Auto Parts (NYSE: AAP) sells aftermarket auto parts, primarily in the eastern United States. A chart of its revenue and operating margin over the last 10 years reveals a robust company in the face of a severe downturn; Advance Auto weathered the 2009 recession with hardly any impact on its profitability.

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Advance's core business, do-it-yourself auto parts, experiences an upswing in demand during recessions because consumers prefer to repair old cars rather than make the larger financial commitment of buying a new one. Moreover, the company's 3,700 stores and relatively high-cost structure provide tremendous operating leverage; when times are good, they should be really good.

Although Advance's overall revenue and profitability have continued to increase in the years since the recession, this is largely due to the company's westward expansion and its growing commercial segment. If the United States plunges into another recession, Advance's top and bottom line should increase even further. As a result, the stock is cheap at 16.5 times trailing earnings, if the economy nosedives.

Big pharma

Pfizer (NYSE: PFE) is another good stock to own in a recession. The company's drugs are usually considered non-discretionary purchases, which is why the company's revenue and profits are uncorrelated with the economy.

Instead, Pfizer's performance is dictated by research and development breakthroughs, prudent acquisitions, and patents. The company weathered the patent cliff relatively well; it did not suffer as sharp a decline in revenue as some of its rivals. Meanwhile, the company continues to generate more than $15 billion in free cash flow each year -- 8% of its market capitalization.

Most importantly, however, Pfizer is the largest research-based pharmaceutical company in the world. This gives it a tremendous advantage in scale; allowing it to spend a low percentage of revenue on research and development while spending a higher dollar amount than its peers.

At 13 times trailing earnings that are uncorrelated with the U.S. economy, investors looking to recession-proof their portfolio should take a closer look at Pfizer.

Waste management

No matter how poorly the economy is doing, the people who collect your trash will always have a job. Waste Management (NYSE: WM) provides a critical service that households and businesses will not discontinue simply for cost savings.

The stock trades at 20 times cash flow precisely because of the company's remarkable consistency and reliability; over the last decade, revenue has oscillated between $11.5 billion and $14 billion as the company struggles to expand beyond its current markets, but its margins have consistently improved as the company finds more ways to serve its existing customers.

Waste Management is not completely immune to recessions. For instance, its customers are more likely to look for alternative providers during economic slowdowns if they can secure a lower price, therefore Waste Management does not have unbridled pricing power. However, the company's industry-leading scale makes it unlikely that a rational competitor will undercut Waste Management on price, except in select markets where Waste Management is not as concentrated. Therefore, the company's profits are largely secure, even in the event of another recession.

At a 5% free-cash-flow yield, the stock is certainly not a bargain. But investors looking for safety of principal during a downturn will meet their goal by investing in Waste Management.

Bottom line

No one can be sure that a recession is around the corner, but investors should be prepared nonetheless. Allocating a portion of your portfolio to recession-resistant stocks like Advance Auto Parts, Pfizer, and Waste Management will give you peace of mind -- and better returns -- if the economy takes a turn for the worse.

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Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends Waste Management. The Motley Fool owns shares of Waste Management. 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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