Equity markets might be trading near all-time highs. However, the market participants seem to be in a phase of uncertainty. Inflation and the timing of interest rate hikes might be key factors that determine the direction of the markets. In current market conditions, it therefore makes sense to be overweight on defensive stocks.
The Federal Reserve has pledged to keep interest rates near zero through 2023. However, the Fed’s Jim Bullard believes that the first interest rate hike might be as early as 2022. The International Monetary Fund is also of the opinion that the first rate hike might come sooner than expected.
Besides this uncertainty, valuations are also looking stretched. The cyclically adjusted price-to-earnings ratio is at 37.98, which is significantly above the long-term average. While I expect the markets to remain in an uptrend, a 20% correction from current levels would not be a big surprise.
Let’s talk about seven defensive stocks that can protect your portfolio in the event of a market crash or sharp correction.
- Pfizer (NYSE:PFE)
- Costco Wholesale (NASDAQ:COST)
- Procter & Gamble (NYSE:PG)
- Dollar General (NYSE:DG)
- Rio Tinto (NYSE:RIO)
- Lockheed Martin (NYSE:LMT)
- BP (NYSE:BP)
Defensive Stocks to Buy: Pfizer (PFE)
PFE stock is among my top picks in the list of defensive stocks. The stock trades at an attractive forward price-to-earnings ratio of 11.5. Additionally, PFE stock has a beta of 0.68 and a dividend yield of 3.73%.
In the near term, the company’s vaccine against Covid-19 is likely to remain the top cash flow driver. For the current year, the company expects revenue of $26 billion from Covid-19 vaccine sales. Further, with an increase in vaccine-manufacturing capacity to three billion doses in 2022, revenue is likely to remain robust.
Several drugs losing exclusivity in the coming years is one reason for Pfizer stock remaining depressed. However, the company has a strong pipeline of drugs in clinical trials. The company expects revenue growth (excluding Covid-19 vaccine) of 6% through 2025.
To put things into perspective, the company has 23 drugs in phase three and another 40 products in phase two. For the current year, the company expects to spend $9.8 to $10.3 billion in research and development. These investments will drive growth even with several drugs losing exclusivity.
Pfizer also has healthy cash flows, which will ensure that dividends sustain. The stock seems to be among the top names for income investors. At the same time, a strong upside is likely after underperformance in the last 12 months.
Costco Wholesale (COST)
COST stock is another quality name among defensive stocks with a beta of 0.68. The company is relatively immune to economic shocks, and business continued to gain traction through the pandemic.
With consumption being the key gross domestic product (GDP) growth driver for the U.S. economy, Costco is likely to remain a performer. For the 44 weeks ended July 4, the company reported healthy comparable sales growth of 16.4%.
For the same period, the company’s e-commerce sales growth was 53.4%. As Costco builds omnichannel sales presence, the outlook is bright. The company’s comparable sales growth in international markets have also been robust.
It’s also worth noting that as of Q3 2021, the company reported 60.6 million household members. This translated into a cash fee of $3.8 billion on an annual basis. With a 91% renewal rate in the U.S. and Canada, the membership fee is a source of steady cash flows.
Costco is also at an early stage of expansion in China. If there is healthy growth in warehouses in the country in the next few years, it will boost membership revenue.
Overall, COST stock is worth holding even after the recent rally. As strong comparable store sales growth sustains globally, the stock is likely to remain in an uptrend.
Procter & Gamble (PG)
PG stock is another name that has been an underperformer in the last 12 months. During this period, the stock has moved higher by 10.44%. However, PG stock is a quality name among defensive stocks and offers an attractive dividend yield of 2.48%.
The company’s strategy of a focused brand portfolio has delivered results. Earlier, the company had 170 brands across 16 product categories. This has narrowed to 65 brands across 10 product categories.
The focused strategy has translated into healthy organic sales growth. During the Covid period, organic sales in the U.S. increased by 13% as compared to pre-Covid organic sales of 5%. With the company also accelerating its e-commerce strategy, growth is likely to remain strong.
PG stock does trade at a forward P/E of 23.8. However, it’s worth noting that the company reported core EPS growth of 17% in 2020. Furthermore, for the first three quarters of the current financial year, core EPS growth was 16%.
Considering the growth coupled with the fact that the stock offers a healthy dividend yield of 2.48%, the stock is attractive. Procter & Gamble has strong presence in under-penetrated markets like India. This is likely to ensure long-term earnings growth visibility.
Dollar General (DG)
I would also add DG stock to my list of defensive stocks. The discount retailer has 17,426 stores in 46 states. It’s worth noting that for Q1 2021, the company reported 260 new store openings.
At the same time, the company remodeled 543 stores and relocated 33 stores. For the full year, the company plans openings of 1,050 new stores. This is likely to translate into healthy top-line growth in the coming years.
Another important point to note is that the company reported operating cash flow (OCF) of $703 million for Q1 2021. This would imply an annualized OCF of $2.8 billion. With robust cash flows, the company is positioned for aggressive store openings and remodeling. Further, the annualized dividend of $1.68 is likely to sustain.
From the perspective of margin expansion, Dollar General is focused on Popshelf brand. The brand targets higher-income suburban customers.
Further, the sale of grocery and household essentials through DG Fresh has also helped in accelerating growth. DGPickup has also supported growth, with the company allowing customers to buy online and pick up at selected stores.
Overall, Dollar General is among the highest quality defensive stocks with a low beta. The company also has aggressive expansion plans, which is likely to deliver value in the coming years.
Rio Tinto (RIO)
In general, commodity stocks have higher volatility and therefore a higher beta. However, RIO stock is among the few exceptions with a beta of 0.62. Additionally, the stock offers a dividend yield of 5.39%, which makes it attractive for a defensive portfolio.
It’s important to note that iron ore is the key revenue and cash-flow driver for Rio Tinto. According to Goldman Sachs, the iron ore bull-market is likely to run at least until 2023. Therefore, it seems very likely that healthy dividends will sustain, and RIO stock will trend higher from current levels.
From a financial perspective, the company reported EBITDA (earnings before interest, taxes, depreciation and amortization) of $23.9 billion for 2020. Further, free cash flow for the period was $9.4 billion. With a net debt position of $0.7 billion, the company has ample financial headroom for growth projects.
Over the next three years, the company has guided for annual capital expenditure of $7.5 billion. Considering the fact that Rio Tinto reported operating cash flow of $15.9 billion for 2020, dividends are safe even with high level of investments.
Overall, RIO stock has further upside potential as iron ore prices remain firm. Additionally, the stock is worth holding for income investors.
Lockheed Martin (LMT)
The defense sector is relatively immune to any economic fluctuations. It’s therefore not surprising that LMT stock has a beta of less than one. Like most of the defensive stocks, LMT stock also offers a healthy annual dividend of $10.40, which translates to a yield of 2.83%.
I also like LMT stock from a valuation perspective. At a forward P/E of 14.3, the stock is likely to see interest from investors in search of value.
In terms of cash flow visibility, Lockheed Martin reported an order backlog of $142 billion as of Q2 2021. The company’s backlog has remained strong through the pandemic period and provides clear cash-flow visibility.
It’s also worth noting that the company reported operating cash flow of $1.3 billion for Q2 2021. This would imply an annualized OCF of $5.2 billion. Strong cash flows are likely to ensure that dividends sustain.
In October 2020, it was reported that most NATO allies will miss the defense-spending target. Therefore, it seems likely that Lockheed Martin will benefit as the defense-spending budget is increased through Europe.
I would also add BP stock to my list of defensive stocks that have an attractive dividend yield. The oil and gas sector has witnessed strong recovery in the last few quarters. With Brent trading above $70 per barrel, BP stock seems positioned for further upside.
I also like BP stock considering the company’s focus on renewable energy for the next decade. The company expects to have renewable energy capacity of 20GW by 2025. Renewable capacity is expected to increase to 50GW by 2030.
To achieve this target, BP plans to invest $60 billion over the next decade in the renewable energy sector. While the company’s oil and gas output will decline by 40% in 2030, it’s likely to be the source of funding renewable investment in the next few years.
Within the renewable energy sector, 83% of the company’s pipeline is focused on solar energy. Over the next decade, solar and wind energy are likely to be the cheapest source of alternate energy.
From a stock price perspective, BP stock has been trading sideways in the last year. Upside from current levels seems imminent for a stock that offers an attractive dividend yield of 5.35%.
On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.