Finding resilient companies becomes particularly important at times of weak economic growth. At BlackRock, our analyst team are looking for certain key characteristics to identify companies that can thrive even in tough times.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Picking the strongest companies is always important, but it is particularly important in the difficult economic environment that faces investors as they make investment decisions. While weaker companies might be able to limp on in more robust economic conditions, they will be exposed in a tougher climate. What are the key criteria for a company that can thrive across different market conditions?
There are important differences between a strong and weak economic environment that can have a real impact for companies’ profitability. Interest rates, for example, will make a significant difference. If interest rates are low, it allows companies with high debt to stay in business. The cost of repaying that debt is lower.
As interest rates rise, that debt becomes more expensive and takes up a larger share of the company’s costs. This is often one of the biggest risks factors for companies in a weaker economic environment. Their profits drop, they cannot pay their debts and eventually, they go bankrupt. As Warren Buffet said: “With long-term debt, increases in interest rates can drastically affect company profits and make future cash flows less predictable.”1
Pricing power
It is a similar situation with pricing power. Pricing power is the ability for companies to raise prices of their products and services. They may be able to do this because they have a strong brand, or their products are in high demand, or, as in the case of areas such as healthcare, their product is unique. Pricing power is always important, but it becomes particularly important at a time of rising costs.
A lot of companies are facing this problem today. Energy costs are rising, alongside higher agricultural prices. Rental costs may also be increasing and staff are demanding salary rises to match inflation. If they can’t pass those additional costs onto consumers, it will hurt their profitability. Equally, during tough economic conditions, the pie gets smaller. If customers don’t have a compelling reason to buy a product, they won’t. Against this backdrop, pricing power becoming more and more important.
Capitalising on tough times
Companies that go into a tough climate in a strong financial position can capitalise. Their indebted, weaker competitors may go bust. This may allow them to build market share, buy their competitors or the assets they leave behind, at a cheaper price. Good companies will often emerge from difficult conditions in a stronger position than they went in.
This is also where a strong management team can be vitally important. A good, experienced management team will understand how to adapt the business to changing conditions, to make strategic acquisitions or sales, which areas to prioritise and where to cut back. They will understand how to put the company in prime position for the recovery when it arrives.
The problem for investors is that these strong, well-run companies can be expensive. Investors see their qualities and the share price may be bid higher. No matter how good a company, if investors pay too much for it, it won’t be a good investment. However, in turbulent market conditions, share prices will often be lower. This can make it a good moment to buy into strong companies at a lower cost.
Our approach
A strong analytical team is a significant asset in a difficult environment. Fund managers need to have the resources to look at a company from all sides, talk to its competitors, its suppliers and its management team. The fund managers across BlackRock’s range of investment trusts can call on a deep global analyst team, with specialists across every sector and in every region.
Competition for capital is a feature of all our portfolio. We run high conviction portfolios and are not swayed by the benchmark weighting of an individual stock. The bar for entry into the BlackRock portfolios is high.
In building these high conviction, stock-picking portfolios, the investment trust structure is helpful. The closed-ended structure of an investment trust means the underlying portfolio isn’t skewed by the need to manage inflows and outflows. The portfolio will always reflect the fund managers’ best ideas, rather than being constrained by the need to buy or sell in a hurry. This can be particularly important in holding the shape of a portfolio in the face of difficult markets.
The final consideration is risk management. Again, this is particularly important at a time of weaker economic conditions when companies may be vulnerable to specific threats. We strive to understand where our risk positions are at any given time – exposure to interest rates, to the oil price, to volatility – and have significant risk resources at our disposal.
Although there may be concerns about the outlook for 2023 – and a temptation to play it as safe as possible – good companies can thrive in all market conditions. The key is finding them. At BlackRock, we have built the infrastructure to find those opportunities wherever they may lie.
