As we saw in March, the realisation that our economy is heading into a recession can cause a stock market crash on the ASX. Whilst the S&P/ASX 200 Index (ASX: XJO) has recovered substantially since the lows we saw in March, unfortunately, we can't say the same about the economy as a whole.
As a result, I think there is a reasonable chance we might see another dip in stock prices, which may or may not bring us back to the bottom we saw on 23 March. On one level, I don't wish to see panic and fear from retail ASX investors out there. On the other hand, I personally would love to buy some of my favourite ASX shares for a rock-bottom price.
But an interesting thing happens when the markets go into full panic mode during a recession. ASX shares are all suddenly tarred with the same brush and indiscriminately sold. It doesn't matter what kind of company a share is, how much money it makes, or how much the coronavirus shutdowns are likely to affect it. The plug is just pulled from the sink.
That's why we saw top-notch shares like CSL Limited (ASX: CSL) sold-off with the rest of the market. And that's why shares like CSL are presently approaching their old highs, while shares like the ASX banks are stuck at multi-year lows.
This is where the real opportunities lie. Investing legend Benjamin Graham once famously remarked that in the short-term, a stock market is a voting machine, and in the long-term, a weighing machine. If everyone is voting 'panic' and 'sell', there's not much weighing going on.
So how does one find the 'baby' getting thrown out with the 'bathwater', so to speak?
How to find ASX winners in a recession
Well, I think the best things to look at are a company's debt and a company's long-term competitive advantages.
Debt is one of the few certainties that a company can give us as an investor. It must be repaid, dependent on nothing. So if a company goes into a recession with a mountain of debt – you can be fairly sure it's going to end up in trouble in most cases. During recessions, credit markets dry up and lenders (if they are lending) will demand 2 pounds of flesh instead of 1. If a company's cash flows dry up at the same time that debt becomes payable, it's trouble!
Meanwhile, a competitive advantage is how a company can build its strength over time. If a business does what it does better than its rivals (think of Coca-Cola making cola drinks), then it benefits from this status whilst other less-competitive rivals suffer and may even go bankrupt. It's a brutal but effective form of capitalist survival of the fittest. And if you can find the survivors, you should do well over the long-term. That's one of the ways Warren Buffett has been so successful.
