Entrepreneurs, managers, business owners and anyone who is interested in financial freedom and wealth accumulation, at one time or another, have all asked “Is there such thing as a recession-proof business?” Wouldn’t we all be flocking to such a business? I bet my last dollar we all would.
First, let me define what recession is. The Chartered Financial Analyst Institute, the current gold standard in the finance profession, has two definitions for recession and they are:
- A business cycle phase in which real GDP or Gross Domestic Product decreases for at least two successive quarters (This is the technical definition – Author’s note).
- A significant decline in activity spread across the economy, lasting for more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade (This is what, we–ordinary citizens–are more concerned with – Author’s note).
Second, based on the second definition I would say that a recession-proof business is one that will not suffer decline in its real income and trade given that the economy it is operating in is in a recession. However, based on the question posted by my fellow Factoider, I would assume that the business he means is one that exhibits growth, in both profit, real or nominal, and sales revenues, no matter what the state of the economy is (boom or bust).
Let us first discuss whether there is a business which profits and sales performances are not affected by a slowdown in the economy. Actually there is. Businesses involved in the buying and selling of commodities could be insulated from the impact of a recession. Let’s look at Wal-Mart (NYSE: WMT). Wal-Mart during the early stages of the US recession reported increases in its store sales and overall company profit. The reason for this is that the demand commodities such as food and basic clothing, in the short run, is inelastic – not immediately affected by the changes in the income and purchasing power of consumers. However, in the long run, this demand will eventually decrease as proven by the most recent report by Wal-Mart (company sales and second quarter earnings declined). Caveat: Not all businesses in the commodity sector experience the same. For example, companies in the energy industry particularly fuel, suffered considerably.
Now, how about whether there is a business that will continually exhibit growth in profit and sales regardless of the condition of the economy. I think that there is no such business. Why? Businesses nowadays no longer operate in a vacuum. What this means is that even if a business is operating in a "recession-proof" industry such as the commodity sector, if it does business with companies in other sectors who have significant exposures during recessionary periods, then in reality it is not isolated from the impacts of gyrations and volatility in its macroeconomic environment.
Perhaps the more important concept that an investor or wealth manager needs to address aside from the analysis of whether there is a recession-proof business, is how to effectively minimize the impact of market and economic downward movements on the overall wealth. This is the concept of asset diversification. This I will tackle in my next articles, so please don’t forget to follow me to get regular updates.
