Undervalued: Finding Stocks In The Upcoming Recession

Sometimes finding good stocks is a difficult task to accomplish. With thousands of companies out there how do you sift through the financial data and pro-forma's to know which stocks are good and which are bad?

To start, multiple sources are vital. It's not only that they will confirm for certain what you think you know. Second and third takes will show you new little layers you hadn't thought to search out.

For another thing, only you can decide the attitude you want to take toward the market.

Should you be bullish or bearish?

There are a few things to consider in the global outlook of the economy when deciding to be bullish or bearish

The US Dollar

Typically, the US Dollar has an inverse relationship to gold and oil. So if you believe the value of US Dollar will decrease than oil and gold should rise.  Gold stocks and gold futures are great to buy when there is a sinking dollar.

Just check out this chart:

This chart points out the last ten years of relationship of the three, US Dollar Oil and Gold.

As the dollar rose from 2011 to 2015 gold and oil started to go sideways and then we're at their lows. You can see from the chart it's a bit of a lagging indicator but as the big money moves from one asset class to the other, you see major moves. 

As a matter of fast hedge funds are more bearish than ever right now on the US Dollar.

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When comparing the US Dollar to the S and P 500 they have had a correlation of .38 on a scale of -1 to 1.

So over the last 20 years as the value of the US Dollar increases typically stocks increase as well.

So keep an eye on the US Dollar and where economic policies have it going.

The Federal Reserve and Interest Rates

It's no secret that the Federal Reserve has stimulated our economy since the recession of 2008-2011.

They pumped trillions into the markets and we saw the markets run into all time highs.

Now that they've stopped the stimulus, the market has been going sideways as the growth in the stock market wasn't based on growth and savings. It was based on manipulation.

They believed with the injection of trillions, the market would correct itself and they could gradually increase interest rates. But we've seen the Fed hold steady on all time low interest rates.

Take a look at the picture above. You can see the period where the federal reserve announces quantitative easing and when they end it.

It's obvious QE worked. But has it run it's course and what are the effects on the market?

What to look for in stocks

The company must be growing

We look at two things when determining when a company is growing or not:

1. Net Equity – Net equity is the measure of a companies liabilities minus it’s assets. If we can see a company growing i’s net equity the company is adding value while decreasing capital outlay. We see this as a positive.
   1. Something we always keep in mind is that not all assets are on the balance sheet. For instance, don’t you think Apple Computers, the technology behemoth has some intangible assets they cannot put on the balance sheet. Apple users are typically “cultish” about their products (more on that later)
2. Gross Sales – We look at the last 5 years of revenue and need to see growth in at least 4 out of the last 5 years of the company. If we do have any negative year, it cannot see a 10% decline or more
   1. The sales of the company need to have a minimum $250,000,000. If the company does not have $250,000,000 it’s unlikely to fit the remaining requirements.

The company must be an industry dominator

When you think of giant industry behemoths, companies that continually out perform their competition, whatever the economic environment, this is what we’re talking about.

Think of Coca Cola for example. Year after year Coca Cola expands it’s brand and dominates the soft drink space.

The company must be recession proof

The economy goes through ups and downs and twists and turns through every cycle. When you think of a falling market you want to think of companies and stocks that have products that you cannot live without, or that it would be rather difficult to live without.

The first company that comes to mind her is Proctor and Gamble. Proctor and Gamble produces and sells beauty, hair, and personal care products worldwide. Toilette paper, razors, deodorants.

Regardless of the economic environment, you’re going to need your TP.

The company must gush cash and return it to shareholders

This is probably the most important factor in this entire list.

Companies can provide value to their shareholders in the form of dividends or buybacks. Dividends because the shareholder receives an “interest” payment from the company or buybacks when the value of their stock instantly increases by decreasing the supply in the market.

We love companies that raise dividends and buy back shares. This is indicative of rewarding shareholders.

The easiest way to find this is to go to Yahoo Finance, click on the Cash Flow Statements, and read the “Dividends Paid and Sale Purchase of Stock” in the lower third of the statement.

If we we’re going to use Proctor and Gamble for example, It will look something like this:

We like seeing increasing dividends year over year and a steady purchase of stock buyback.

But to measure relativity of dividend payout and sale purchase of stock, we’ll compare it to gross profit, which is the money left over after the cost of the revenue is deducted from the cost to generate it. This is the available capital left over to provide shareholders with the “bonus”:

You can find that in the income statement.

We see for the year 2015 P&G had 37,403,000 in gross profit and returned 7,287,000 in dividends and 1,778,000 n share buy backs.

That is a total investor return of gross profit of

9,065,000/ 37,403,000 = 24%

Anything above 20% is fantastic.

In Conclusion

We here at The Capitalist believe that the US Dollar and the Federal Reserve drive the stock market. By following these two things, in a macro basis, you should be able to decide whether being bearing or being bullish is the best stance.

By Following the fundamentals of stocks as stated above, you'll be “head and shoulders” above the rest.