This is a continuation of my 10 part series on the core concepts I am focusing on in this difficult market environment. (Part I)
In any business you have to make money and margins determine the difference between a profit and a loss. In an environment such as this I’m not concerned at all with companies who lose money – period. A company’s earnings may decline year over year due to lower demand or higher input costs, but they have to make a profit and concentrate on their margins when they can.
I want to focus on stocks that can sustain or protect their margins against cost erosion regardless of what market they’re in. This goes back to my belief that no company is recession proof, but instead recession resistant. It’s what you can do in the hard times that often show which companies have the superior management.
If a company can focus and sustain their margins than they should be able to stand up against the expectations of the market fairly well. What the market has clearly demonstrated as of late, regardless of long-term fundamentals, is intolerance for companies who mismanage their margins. Now that’s not to say that an investor should discount solid long-term fundamentals, but you have to be aware that the market will have little patience for those who announce pricing pressures.
You want to focus on companies that have perpetual demand across their entire portfolio of products or services and benefit from a sustainable competitive advantage that protects their margins from industry compression. The industry may drop prices due to lower demand, but your company will continue to profit because their margins are higher due to their SCA.
Bottom Line: If you notice margins coming down significantly without management addressing the problems publicly or providing an adequate explanation then sell. If a company doesn’t make a profit in back to back quarters – SELL IT.
Suggested Stocks I Own: Proctor & Gamble (PG), General Mills (GIS), Campbell Soup (CPB) & Baxter (BAX)
Good point. This often has a lot to do with brands and pricing power. I also really like Clorox (CLX), but the stock has had a nice little run here. If it fades back down to below $55 I am going to start to look at it again. Typically most of these stocks are already expensive unless you reall look outside the box, and away from consumer goods.
I would add JNJ to this bunch as well. Most analysts claim that certain stocks are recession proof. I believe however that few if any stocks are depression proof 🙂
MG – CLX is a fantastic company and one (I hope) to own someday. But I couldn’t quite catch it earlier in the year and likely will try sometime when its valuation is a little more reasonable.
DGI – I absolutely LOVE JNJ (and you’re not supposed to love stocks). Likely one of my “best managed” stocks that I own. I think this will be a period if we experience really tough economic times that the true leaders emerge from the rubble to gain new heights. I don’t think you’ll see the same 10 history over the next 10 years.