How to Pick Stocks In a Recession

Picking winning stocks at any time is tough, but doing so in a recession is even harder. Follow these steps to improve your chances at finding the diamonds in the rough.

Difficulty: Challenging

Instructions

1. Though stock-picking aims to find single outperforming companies, it makes sense to look at the investing world and economy in a much broader sense to start.
   
   Recessions can come in many flavors. Some are accompanied by inflation, other by deflation. Interest rates, commodity prices, money supplies, political environment and many other factors can set the course of the economy. Knowing the specific environment can help you choose your investment plan.

2. Once you have a handle on the macro economic environment you can form an opinion on which industries or sectors of the economy will outperform. General opinion is that consumer staples and health care are safer in recessions since these consumer expenditures are largely non-discretionary.

3. Once you have a sector you think will do well, splice it even further. Would you expect a fancy, organic grocery store to do better than Walmart in an environment where consumers are cutting back on spending? Both are considered consumer staples, but they are obviously different.

4. With a superficial view on which companies or type of companies will do well in the recession, it is time for a more rigorous scrubbing of the prospective company's balance sheets. Just because a company is good does not mean the stock is a good investment.
   
   Examine the company's cash and current debt position. Obviously high cash and low debt is preferred. Current debt is more important than long-term debt because it may need to be paid out of cash or refinanced during the recession, which may be hard, expensive or impossible. This could be big trouble for the company if there isn't much cash. Also look at profit margins to see if there is room for compression and inventories, if they are building up and will probably have to be sold at lower prices.

5. The last main point would be to really examine the dividend. Higher yield is not always better. Common knowledge is that dividends protect from large downturns, but remember they are not guaranteed. Check what percentage of earnings or cash flow is spent on the dividend. If the ratio is too high, the company may reduce or eliminate the dividend to preserve capital.

Tips & Warnings

• Be careful. Picking individual stocks can be hazardous to your wealth. Stocks that outperform in a recession still often go down...just not as much as everything else.