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Choosing stocks that do well when times are tough

Take a very simple approach to the possibility of recession, says this U.S. advisory — choose stocks that don’t depend on good times.

The idea couldn’t be simpler. Companies that depend on a strong economy aren’t going to do as well when the economy is weak.

According to many experts, that doesn’t mean you should ignore them entirely. You’ve undoubtedly heard over and over again that a good company whose shares are down is a great bargain. Buy low and wait for the stock to go marching back up.

But why not buy stocks that are going to do well even if the economy is not thriving? These companies may have their shares pushed around in a convulsive market. They may get caught up in recession fears that have nothing to do with their own performance. But because the companies are still making lots of money, they can snap back much quicker.

That’s the approach of Louis Rukeyser’s Wall Street, which suggests several stocks that are liable to prosper even as the economy tightens. But these are not the usual suspects, such as utilities or consumer stocks. (And of course one sector that is normally among the usual suspects — finance — is the chief culprit in the current crisis.)

The first of this advisory’s picks is in a business that ought to suffer during a recession. Let’s solve that mystery right away.

Services not a luxury

We know who’s not going to do well in an economic slowdown or recession. “Makers of machinery and tools, for instance, are hit hard by economic slowdowns because the factories that buy such products tend to cut back on production,” writes Mr. Nikolas Lanyi, editor of the advisory.

“It’s also assumed that consulting firms also suffer, because corporate belt-tightening often results in lower budgets for spending on extras, such as outside help. But what about consultants whose services aren’t a luxury?”

Nothing could be less of a luxury to most corporations than the smooth functioning of their Information Technology (IT) divisions. That’s what makes Accenture (NYSE-ACN) a good buy in this advisory’s books.

In the 1990s, companies built up their own IT departments, but that has changed. Increasingly, they have come to hire consultants and outsourcers to make their operations as efficient as possible. At the same time, IT spending in the developing world is exploding, calling on yet more expertise from those consultants and outsourcers.

“These trends are unlikely to change much in the coming years,” says Mr. Lanyi, “regardless of what the economy does in 2008.”

Double-digit revenues

Accenture is one of the top IT consultants in the world. Once the consulting wing of Arthur Andersen, it broke away from that scandal-wracked accounting firm to form a powerful entity of its own. It has 150,000 employees in over 50 countries around the world.

Its sales are roughly divided among three divisions: consulting, or helping companies develop an IT strategy; technology which normally involves working at a firm to integrate new software; and outsourcing, or taking over the management of a company’s IT network and other “back-office” functions.

Half a dozen years ago, when the dot-com bubble burst and IT spending shrunk, Accenture suffered along with the rest. Since then, its sales and earnings have risen steadily over the past five years with revenues growing by double digits year over year.

Cheaper to consult

Almost half of Accenture’s employees — 700,000 — are located in India, China, Eastern Europe and the Philippines. That means they cost less than workers in the United States and other developed nations. This in turn helps give Accenture the highest profit margins of any U.S.-based IT consulting firm.

“Even in a recession, it’s not a foregone conclusion that companies would cut back significantly on such expenditures,” says Mr. Lanyi. In fact, it might just be the most efficient strategy when times are tough. “Certain types of consulting and outsourcing actually save companies money, because it’s less expensive to hire outsiders to handle complicated tasks than to recruit and retain highly skilled workers — especially with health-insurance costs on the rise.”

What’s more, technology is not getting any simpler (anybody who owns a computer is bombarded with new upgrades — think about the implications for a whole company). It’s not easy for a company to show its consulting firm the door when it’s dealing with such needs as advanced data management, remote access and network security.

Financially, Accenture is in very good shape with little debt and almost $3.5 billion in cash, which it uses to buy back its own shares, make acquisitions or move into new markets.

Weathering the storm

When all is said and done, a deep recession could still hurt Accenture’s revenues. “Still, compared with truly economically sensitive companies, Accenture is well positioned to weather the storm and resume progress on its long-term growth track.”

Recession fears have pushed the company’s shares down in the $35 range, well below their 52-week high. But revenue is still expected to grow at over 10 per cent and earnings per share at over 12 per cent for the next few years. The stock is trading at only about 15 times estimated 2008 earnings, so it’s decidedly undervalued.

The shares could still fall, of course, in this up-and-down market. “But given their already-low valuation and the company’s growth prospects,” concludes Mr. Lanyi, “this is a great buying opportunity for long-term investors.”

We might add that another U.S. advisory we consult regularly makes Accenture one of its top picks on a special list of stocks that combine a dividend yield above 1 per cent with strong fundamental scores.

Speaking of yield, the advisory’s second pick is handing out a lot of money.

Built-in safety feature

This is not your usual definition of a defensive stock for tough times: an airplane leasing firm in Ireland.

In fact, it looks a lot more like a growth stock than a conservative one. It’s in a business that is growing by leaps and bounds. But it does have one nice built-in safety feature — it pays a ton of dividends.

Genesis Lease Ltd. (NYSE-GLS) is located in Shannon, Ireland. Shannon is a major stopover and refuelling point on the Atlantic run, which makes it a convenient location for the company.

The business is growing for a very good reason, as Mr. Nikolas Lanyi explains. “Airplanes are very expensive, and have a limited lifespan. Rather than face a huge expense for a new plane every few years, it makes sense for airlines to pay a monthly fee to lease a relatively fresh plane for 10 years, then turn it in and get a new one.”

Even if the lease rates rise, it’s still a lot cheaper than a new plane. The leasing company does repair and maintenance, so the airline doesn’t need to keep a huge maintenance staff. And it’s not stuck with excess capacity during down periods in travel. It’s pretty much win-win for the airlines.

Spun off from GE

Air travel is up around the world. Despite all the troubles and failures in the airlines industry in North America and Europe since 2001, the number of airlines is actually growing around the globe. In the developing world, business and leisure travel are both on the rise. The number of commercial aircraft should double in the next 25 years, from about 18,000 to 36,000.

Spun off from General Electric, Genesis has used the management skills of its former parent to surge ahead. It bought GE’s entire global network of 230 customers, and over a third of its business comes from the ever-desirable Asia-Pacific region.

All that lease money contributes to a rich flow of cash. And Genesis turns that cash over to its shareholders in the form of quarterly dividends. And that dividend of $1.88 is currently yielding a whopping 11.88 per cent. We had a story from another advisory this week that warned against putting an inordinate amount of faith in yields, but that double-digit number is too impressive to be ignored.

Genesis has seen its shares fall recently simply because it’s a leasing company and “all leasing companies got caught up in the bear market for financial stocks,” says Mr. Lanyi. “But Genesis’ business has nothing to do with subprime mortgages, so investors’ concerns weren’t warranted.” The stock currently trades at $17.50.

A worldwide recession could hurt the leasing business, but even then it would be worth going along for the ride, says the editor, because “this is a great long-term buying opportunity for a high-yielding stock with excellent long-term prospects.”

It would be nice if companies that were doing well were always rewarded by the stock market. But lately the market has been kicking everybody around indiscriminately. If this advisory is right, you’ll be better off picking stocks that are doing good business and trusting they’ll get their reward sooner rather than later.