Tuesday, September 1, 2009

When Bad Times Are Good

Demand for goods and services generally drops during recessions. It is for this reason that value investors prefer companies structured to withstand such drops. When incomes fall, certain industries suffer disproportionately. For example, we saw that for every 1% drop in US incomes, airlines actually lose about 6% of their revenue!

But on the other side of the coin, it should be noted that there are actually products for which demand increases as incomes drop! These products/services are referred to as inferior goods, since people buy these instead of buying a product they actually want but can't afford! Tutor2u classifies frozen veggies, processed cheese and tinned meat among this group of inferiors.

With US job losses climbing to local highs and continually rising unemployment, companies that provide such products may actually find themselves in boom times! Such companies tend to be non-cyclical, and can therefore take on more debt and still remain safe, thus offering shareholders a tax break. For example, consider Kraft (KFT). Although Kraft provides a wide variety of products, one could argue that many of their processed and packaged foods are precisely the inferior goods which see demand increases when incomes drop.

Indeed, Kraft's stock is only down about 20% from its 2007 high, as it continues to post increases in operating income. But as a largely followed, well-covered stock, it doesn't offer the same value as many smaller businesses that also benefit from recessions but that have seen their stock prices get pummeled. What small companies appear poised to see increases in revenue and earnings in this environment thanks to the types of products they sell?

1 comment:

Anonymous said...

I would argue that for the average consumer, the majority of Kraft's brands are superior than other brands or private labels.

For example: What sandwich cookie is better than an Oreo? The average consumer has been willing to pay more for an Oreo over substitutes for almost 100 years. That's why Kraft/Nabisco has been able to raise the price of an Oreo above the rate of inflation--even during periods of high inflation.

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