No doubt there are stocks investors have made over 40percent returns year-to-date ( YTD), but in a recessed economy like Nigeria, equity buyers need to act cautiously.
Knowing which stock to avoid investing in can be just as important to an investor during a recession as knowing which companies make good investments.
It was officially established last week that Nigeria has recorded significant decline in general economic activity –identified by a fall in GDP in two successive quarters. Nigerian GDP contracted 3.6percent in third quarter of 2020 from year earlier.
Also, as revealed by the National Bureau of Statistics ( NBS), inflation rose for the fourteenth consecutive time in the month of October. Driven by higher fuel prices, supply chain disruptions and a weaker Naira, headline inflation rose to 14.23percent year-on-year (y/y) (September: 13.71percent).
These disappointing economic numbers could make investors rethink their position in some stocks and further route to take profit from recent gains.
Crude oil futures had ended higher on Monday (Brent crude +$1.10 or 2.5percent to $46.06 per barrel), with support tied to continued progress on vaccines against Covid- 19 even as the disease continues to rage afresh in parts of the world.
Read Also: Early budget passage saved Nigeria from worse recession Senate president
For FX earnings, the short-term outlook doesn’t look promising to Nigeria which its oil production fell to 1.67 million barrels a day from 1.81 million barrels in the previous three months.
In relation to what Nigeria’s naira could buy 5 years ago, and what it can buy today, the celebrated returns at her stock market mean relatively less value for investors.
Investors who want to survive and thrive during a recession will invest in high-quality companies that have strong balance sheets, low debt, good cash flow, and are in industries that historically do well during tough economic times; while companies and assets with the biggest risk during a recession are those that are highly leveraged.
Interestingly, some stocks have yielded over 40percent returns year-to-date (YTD).
They are: Africa Prudential (+ 43.8percent), Airtel Africa (+ 75.7percent), BUA Cement (+60percent), Dangote Cement (+40.7percent), Dangote Sugar Refinery (+41.2percent), FCMB Group (+ 59.5percent), Fidson (+ 74.2percent), and Livestock Feeds (+152percent).
Others are May & Baker (+65.8percent), MTNN ( + 4 5 . 7 p e rcent ) , Neimeth (+250percent), Northern Nigeria Flour Mills (+ 79.1percent), Okomu Oil Palm (+43.9percent), Presco (+ 51.2percent), United Capital (+75percent), Vitafoam (+56.8percent), and Lafarge Africa (+44.1percent).
In a recession, it would be wise for investors to avoid highly leveraged companies that have huge debt loads on their balance sheet. These companies often suffer under the burden of higherthan-average interest payments that lead to an unsustainable debtto-equity ratio.
While these companies struggle to make their debt payments, they are also faced with decrease in revenue brought about by the recession. The likelihood of an abrupt drop in shareholder value is higher for such companies than those with lower debt loads.
There are companies that tend to do well during boom times when consumers have more discretionary income to spend on non- essential or luxury items. Those companies’ earnings are often tied to employment and consumer confidence which are always battered in a recession.
Simply put, stocks that move in the same direction as the underlying economy are at risk when the economy turns down.
When the economy weakens, consumers typically cut back their spending on these discretionary expenses. They reduce spending on things like travel, restaurants, and leisure services. Because of this, stocks in these industries tend to suffer, making them less attractive investments for investors during a recession.
Another type of stock to avoid in this recession are those that have not yet proven their value and are often seen as “under-theradar” opportunities by investors looking to get in on the ground floor of the next big investment opportunity.
These high-risk stocks often fall the fastest during a recession as investors pull their money from the market and rush toward safe-haven investments that limit their exposure during market turbulence.
The current recession, no doubt comes with difficulties, but it also coincides with the best opportunities for those hunting for value.
Though it might be tempting to ride out a recession with no exposure to equities, investors may find themselves missing out on significant opportunities if they do so.
Generally, there are companies that do well during economic downturns. By simply studying a company’s financial reports, an investor can determine if that company has low debt, healthy cash flows, and is generating a profit. These are all factors to consider before making an investment.
A good investment approach during a recession is to look for companies that are maintaining strong balance sheets or steady business models despite the economic headwinds. Some examples of these types of companies include utilities and basic consumer goods conglomerates.
It might seem surprising to hear that some industries perform quite well during recessions. These stocks tend to do well during recessions because their demand tends to increase when incomes fall or when economic uncertainty prevails. Investors should look out and add to their portfolio those stocks operating in industries that are seen to be recession-resistant. Many of these companies see an increase in demand when consumers cut back on more expensive goods or brands or seek relief and security from fear and uncertainty. Take for instance, during this yuletide, many cash strapped Nigerians who cannot afford to travel by air may consider travelling by road, meaning more earnings for companies offering such services.
