Use This Blue Chip To Avoid The Next Recession

Amber Hestla's picture

Wednesday, April 15, 2015 - 7:30am

by Amber Hestla

April will be the 70th month of economic expansion for the United States.

That seems like a long amount of time, but it's not abnormal. The last three expansions in the United States lasted an average of 95 months, with the longest lasting 10 years.

Using recent history as a guide, we can estimate how far away we are from the next recession (about two years based on the average expansion length). But we have no way of knowing if our current expansion will end before then or maybe set a new record.

Not even economists know when we'll transition from one phase into the next. In fact, economists generally don't know that we're even in a recession until 6-12 months after it begins.

Knowing that we're most likely nearing a later stage of our expansion, my focus has turned to what comes next. More specifically, I want to know whether the companies I'm investing in are prepared for the end of this expansion.

While it's not possible to know when the next recession will start, we can work around that by investing in companies that perform well during both feast and famine. If a company takes steps to prepare during the expansion, it should be able to maintain profits in an economic downturn.

In many ways, good companies follow the trite advice of buying an umbrella before it starts raining. I was recently in New York City, and as soon as it started raining, umbrella sellers appeared on street corners charging $10 for umbrellas that would have cost less than $5 an hour earlier. By carrying an umbrella before it started raining, I saved money and made it through the storm without getting soaked.

Companies face the same problem. Waiting until after the storm hits to take action is often more costly. However, companies know there will always be another financial storm -- every expansion is followed by a recession -- so smart companies prepare for that inevitability. 

When evaluating investment options, part of my process involves analyzing how prepared a company is to handle an economic slowdown. One way I do this is by looking at cash flow -- the cash that's left over after reinvesting in the company and paying expenses like wages, debts and dividends. In the short term, cash flow can be more important to a company than profits.

During a recession, companies with stronger cash flows are more likely to keep operations running smoothly. Without strong cash flow, management may have to make drastic decisions like cutting dividends, laying off employees or selling assets to offset falling sales.

The company I am recommending today is a blue chip that is well prepared to weather the next financial storm: General Motors (NYSE: GM)

GM is one of the largest car makers in the world, ranking third in global sales in 2014. Its recent financial results have been solid. Last year, the company reported total revenue of $155.9 billion and net income of $2.8 billion, or $1.65 per share. It also ended the year with more than $25 billion in cash on its books. When you consider that the entire company is worth $59 billion based on its market cap, that's an incredible amount of cash to have on hand.

Despite such strong financials and continued growth, GM is actively prepping for the next economic famine. And for good reason -- car and light truck sales are closely tied to economic growth, as you can see in the chart below. 

In a recent presentation to shareholders, management detailed its plan for meeting the next recession head on.

As I noted, cash is often the key to surviving an economic downturn, and management believes it will take reserves of $20 billion to $21 billion to keep things running as usual. This amount includes $8 billion to continue operations through the recession, $5 billion to $6 billion to cover the expected decrease in working capital, $5 billion to cover interest and dividend payments, and $1 billion to $2 billion excess cash to assure ratings agencies that its debt obligations shouldn't be downgraded. This plan envisions a two-year recession, but if the recession is deeper than expected, GM has established revolving lines of credit that it can tap into for emergency use.

I believe GM's strategy makes it a safer investment than it was even a few years ago. The company seems to have considered every angle, and it even has a plan for what to do with cash balances above its reserve requirements. Excess cash will be returned to shareholders, starting with a $5 billion share buyback plan the company announced in March. Management also recently increased the quarterly dividend by 20% to $0.36 a share.

I often use the PEG ratio to determine a stock's fair value. A stock is considered to be trading at fair value when the price-to-earnings (P/E) ratio is equal to its earnings per share (EPS) growth rate, yielding a PEG ratio of 1.

Analysts expect GM to earn $4.62 per share in 2015 and grow earnings at an average of 17.9% a year for the next five years. With a P/E ratio of 8 based on 2015 earnings estimates, GM has a PEG ratio of 0.4, signaling it is currently trading at less than half its fair value based on this metric.

I believe the stock is deeply undervalued because investors are still concerned about the problems that sank the old GM. In the most recent financial crisis, GM went through a very public bankruptcy, but its reorganization allowed it to reduce its unfunded pension obligations and other debt from $88 billion in 2007 to $27 billion at the end of last year.

In addition to lowering its debt, GM took steps to align management compensation with shareholder interests. At the "new GM," base salaries account for just 13% of management's compensation. The other 87% is unlocked only by meeting short- and long-term performance goals.

The new GM seems to be ready for the next recession and is a "buy" at the current price. 

Before I sign off, I want to share one more thing with you. GM is already an attractive income opportunity with a dividend yield near 4%. Its next quarterly payment of $0.36 will be made on June 23 to stockholders of record as of June 10. But there is a way for traders to triple that income. 

Specifically, you can buy shares and immediately get paid an additional $0.74 per share. When combined with the regular dividend, you're looking at an annualized yield of about 12%. You'd be hard-pressed to find another blue chip yielding that much. What's more, this extra income, which you can collect every few months, gives you added protection in the event of a downturn. To learn how to collect this extra payment now, follow this link.

This article was originally published on ProfitableTrading.com: Start Preparing for the Next Recession Today With This Blue Chip

Amber Hestla does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.