How to Make Money from Bankrupt Governments

What's the biggest problem for the stock market these days?

Yes, unemployment is high and growth appears to be slowing. Savers are being punished with paltry yields. News flow from the Euro-zone is raising an infinite number of questions regarding the health of member economies.

But the biggest problem - which contributes in whole or in part to most of the aforementioned problems - is too much government debt .

This pain point can be alleviated in a variety of different ways - too many to discuss here. I think it's more productive to discuss opportunities, like; how do we make money from bankrupt governments?

The mere fact that we know this problem exists should start investors down the right path to figuring out how to profit, despite the problem.

We just have to find companies with solutions that address the pain points resulting from said problem. Do this and you give yourself the potential to profit even in a weak stock market.

A number of months ago I sat down to figure out a way to get ahead of this problem.

In short, I wanted to find a company that would profit from the fact that the United States Federal Government is in serious financial trouble.

We are currently up nearly 20 percent on a resulting recommendation over a period when the market has been consistently falling.

I believe the story of uncovering this stock can help you similarly pinpoint stocks that have the potential to outperform in today's market. The name of the company isn't important - it's the process that you should care about.

It was critical to first pinpoint the problem - then create a watch-list of companies addressing the pain points in order to turn this knowledge into profitable investments.

Let's get back to 'The Problem '

Investors have grown weary hearing about state and country budget deficits, crushing debt burdens, proposed austerity measures and the plethora of associated problems that stem from those politicians who forget the most simple austerity measure of all...

Spend less than you make and you will be ok.

This simple logic - which leaves no room for political posturing and lobbyist-infused nuance - has been overlooked by many leaders who make the hard decisions required to run governments around the world.

Don't get me wrong. I believe there are many people in government who are brilliant, hard working, and trying to do what's best for their fellow citizens - and for the world.

But some problems, like the debt issues facing Greece, Italy, Spain, and the U.S., are so complicated and involve so many players that they can't - and won't - be resolved quickly.

Witness the swift exit of Germany's Juergen Stark from the European Central Bank (ECB) - perhaps the beginning of the end of the Euro?

Broad based sovereign debt issues are clearly a problem. But what are the precise pain points that could be used to find opportunity?

The 'Pain Points'...

1. Governments need to increase revenues.

2. Governments need to decrease spending.

3. Governments need to be more efficient in how they spend.

The U.S. knows it's backed into a corner right now. State and local government payrolls are shrinking as services are cut to shave costs. Despite these cuts, over the past three years states have faced the largest budget shortfalls on record.

The Center on Budget and Policy Priorities (CBPP) revised its projections in June, and found that in "...addition to the $430 billion in shortfalls that states already closed in 2009, 2010, and 2011 combined... 24 states have projected shortfalls totaling $46 billion for FY2013."

42 States Shortfalls

Many of these 24 states budget for two years at a time - once the remaining 26 states complete their 2013 budgets, the picture will likely get worse.

The CBPP reports that currently 42 states project a combined budget shortfall of $130 billion in 2011. Unless you live in one of the 8 white states in this map (or outside of the U.S.), your state has a projected deficit.

The consequences are being felt around the country.

Services to residents are being cut and taxes are going higher. The downward spiral becomes harder to break the longer the situation goes on - budget cuts hit even harder when in a recession because government revenues are already depressed.

Under current policies, the CBPP estimates that U.S. debt will explode to 100 percent of GDP by 2030, and to 300 percent of GDP by 2050.

The Solution...

What should a company do to address this pain?

Build a product that makes the government more efficient (i.e. saves it money) or one that helps the government make money (i.e. brings in revenues, not by raising taxes).

One small company I uncovered helps governments do just this.

This company's products increase state and local government revenues without creating additional taxes on citizens.

In 2010 well over 50 percent of its revenues came from government bodies. The U.S. Department of Defense (DoD) has named this company its exclusive contractor for one of its specialized services.

In the last quarter the company grew revenues by more than 20 percent year-over-year. It also increased its guidance for the next quarter and for FY 2011.

Over the last couple of weeks this stock rose by nearly 30 percent. I believe it is entirely possible that the stock could hit my price target as its products continue to address the U.S. government's pain points.

Because I just recommended this stock to paying subscribers, I can't release its name yet. But this particular company's name is beside the point - it is the strategy that led to this company that is the message today.

Figure out the potential problem(s) and the customers that are plagued by these problems. Then find companies with solutions that address the pain points.

In this case the customer is the U.S. Government, but it could be any customer; a retailer, an industrial concern, or a high tech company.

Customers will buy the company's products because they will have no choice. Buying the product will be less expensive than doing nothing - it'll be a no brainer.

You'll own the stock and you will make money, even in a down market.

That's the strategy for making money off bankrupt governments - it'll work for other problems too.

One final note... my colleague and friend Andy Crowder has a similar knack for homing in on potential moves in the market. This weekend, Andy will be showing a small group of Small Cap Investor readers exactly what his next moves are. He's got a unique strategy that's simple, yet effective.

This is a free event with no strings attached, and you can get all the details here.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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