Investors can find it beneficial to take stock of the economic environment and rotate in and out of sectors based on the economic climate. For example, when the economy is coming out of a recession it is usually a good time for early cyclicals like homebuilders and banks. During expansions, tech tends to do well, and during a recession, defensive stocks tend to perform best.
But what is a defensive stock, exactly? Defensive stocks are usually consumer non-discretionary stocks, which are in the business of selling something that consumers will buy regardless of the state of the economy.
Defensive stocks are generally "sleep at night" companies. They are often mature businesses that generate stable cash flow. They tend to pay high dividends as well. While they don't have the sizzle of the fast growers, they are often great companies for income investors and those that are more concerned about taking on too much risk. In a recessionary environment, their businesses should be the least affected.
Here are a few defensive stocks to keep on the radar when you see the economy begin to weaken (like it is at the moment).
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1. Unilever: The global consumer products company
Unilever (NYSE: UN) (NYSE: UL) is the classic defensive stock. The Anglo-Dutch conglomerate is a truly global company, which means it has consumers all over the world. If the U.S. enters a recession, it doesn't necessarily mean that Asia or South America will.
Then there's the fact that Unilever has some of the top consumer brands out there, including Axe body products, Lipton teas, Dove soaps, and Hellman's mayonnaise. Consumers also tend to be very brand-loyal with these goods. Unilever has weathered COVID-19, with first-half 2020 sales down 0.1% from a year ago. With people spending more time at home, sales of food, ice cream, and tea rose, while personal care spending fell. The stock is up about 4.5% this year.
One pro tip to consider: Unilever trades in the United Kingdom and in the Netherlands, which goes back to the 1920s when Dutch company Margarine Unie and British company Lever Brothers merged. The stocks are not fungible, but they do represent the same ownership. The UN ticker represents the Dutch shares, while the UL ticker represents the British shares. UN trades at a discount and has the same dividend and earnings of the UL, so save yourself a buck and change per share and buy UN, the cheaper one.
2. CVS Health: Drugs and healthcare
CVS Health (NYSE: CVS) is more than a drugstore and is an example of another company that will be relatively unaffected by a recession. COVID-19 had a positive impact on CVS, as the biggest beneficiary was the insurance segment, which paid out fewer health insurance claims as people deferred elective procedures. The company estimated on the earnings conference call that COVID-19 boosted second-quarter earnings per share by $0.70 to $0.80.
But regardless of the COVID-19 pandemic, foot traffic in CVS stores isn't going to be affected all that much from a recession. People still want vitamins, over-the-counter medicines, and greeting cards. CVS trades at nine times estimated 2020 earnings per share and pays a 3% dividend yield.
3. Duke Energy: The ultimate "sleep at night" type of company
Duke Energy (NYSE: DUK) is a public regulated utility that provides services in much of the Southeast and the Midwest. Regulated utilities have an unusual business model in that the individual states each have a public utility commission which negotiates with the company over how much consumers may be charged for service. While the public utility commission has an incentive to get the lowest price possible, if they go too low, they risk putting the utility into financial distress, which helps no one. This means that the utility cannot price gouge, but it will make enough to earn a decent return.
Utility companies are generally boring businesses that allow the investor to sleep at night. Duke Energy trades at 15.9 times expected 2020 earnings and has a 4.8% dividend yield.
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Brent Nyitray, CFA has no position in any of the stocks mentioned. The Motley Fool recommends CVS Health and Duke Energy. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
