Investing in 'Fortress' Stocks

Worried about the credit crunch, slower growth, and falling profits? Consider some companies that could fare well even in the worst of times

by Ben Steverman

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These are scary times for stock investors. The credit crisis continues to claim victims up and down Wall Street; earnings growth is the slowest in five years; stock traders keep seeing wild, volatile sessions on Wall Street; and many economists, including Federal Reserve Chairman Ben Bernanke, are worried about an economic slowdown, if not a recession, in the next several months.

Where do you hide when things look bleak? We asked a dozen fund managers for their nominations for a "fortress portfolio"—a group of companies that have shown they can withstand difficult conditions. Although no stock investment is entirely safe, these resilient stocks should offer at least some protection if the rest of the stock market takes a hit.

The key criterion for a fortress stock: Some quality must protect its business even in tough times. Read on for a roundup of potential fortress stocks and the qualities that protect them.

Little Luxuries

For Diageo (DEO), recommended by Greg Church of Church Capital Management, protection comes from its well-known alcohol brands, which include Smirnoff, Johnnie Walker, Baileys, and Guinness. "Global brands are the place to be in the future," Church says, as a growing middle class, especially in Asia, demands the same products that Western customers enjoy. Plus, companies that make booze have a good track record in recessions. "When you have downturns, people tend to drink more," Church says.

In difficult times, people may cut back on spending, but not everything gets hit equally. Many companies offer necessities consumers simply can't do without, or small luxuries—like that extra round of beer—they don't want to give up.

Falling in the category of small luxuries is Coca-Cola (KO), recommended by Jay Wong and Chris Orndorff, co-managers of Payden & Rygel's U.S. Growth Leaders Fund. Few customers will stop buying their Coke or Diet Coke in a downturn. That has given Coca-Cola a reputation for consistency. "It's a very steady grower, and as a result of that it is a good kind of stock to own in this environment," Orndorff says. Coke, like many other fortress stocks, has strong exposures to fast-growing foreign markets, and most of its profits are overseas.

On the Menu

McDonald's (MCD) should also hold up even if no one really needs fast food, says Carol Miller and Dean Kartsonas of Federated Investors' (FII) Capital Appreciation Fund. McDonald's dollar menu appeals to even the most cash-strapped consumer. At the same time, "they've really improved the quality of the food," Kartsonas says, giving McDonald's a better chance of drawing customers away from more expensive, sit-down restaurants.

Smithfield Foods (SFD) is the country's No. 1 processor of pork. Low hog prices have hurt its stock, but Ted Baszler, portfolio manager of the Heartland Advisors' Select Value Fund, likes Smithfield for its recent growth strategy. Through acquisitions, it has been buying up brands and moving into higher-profit products including sandwich meat, hot dogs, and Butterball turkeys.

Strength in Necessity

Also falling in the category of necessities is Waste Management (WMI), recommended by Jerome Heppelmann of Liberty Ridge Capital. Waste Management has a simple, consistent business strategy, he says: "They pick up garbage." Even in a downturn, there's no reason to think customers won't need that service. Plus, the nation's largest waste hauler has pursued a new strategy of raising prices and not competing for less profitable business, a strategy Heppelmann likes.

A similar play is Stericycle (SRCL), the largest U.S. handler of medical waste. Its 375,000 customers are locked into long-term contracts, and it's growing both organically and by acquisitions in its highly fragmented market, says J. Bary Morgan, chief investment officer of Baird Investment Management. Not only is Stericycle insulated from a recession, it's the beneficiary of a long-term trend: "the growing use of health care in this country," Morgan says.

Morgan also likes Iron Mountain (IRM), which helps companies with record storage and destruction. It's a stable business with strong growth as more rules and regulations spell out exactly how long records must be stored. Iron Mountain also is trying to expand internationally.

Factoring Dividends

When looking for fortress stocks, fund managers look for companies with good dividends. A high dividend yield gives you income while you wait out a bear market. And dividends are taxed at a lower rate than income from other investments, such as a money market fund, says Dan Genter, president and chief investment officer of RNC Genter Capital Management. He thinks shares offering dividends will outperform the broader market: "You have a big demand for these stocks as the baby boomers are retiring," Genter says, because many boomers will want security and income but won't want to go to a super-safe, all-bond portfolio.

Liberty Ridge's Heppelmann likes the high dividend from General Electric (GE), as well as its strong growth prospects, as it supplies aerospace, turbines, and other heavy equipment to a fast-growing world.