Now could be the time for defensive stocks to shine.
While growth stocks often generate headlines and excitement, they pose considerable risks, as we are currently witnessing so far in 2022. Many popular plays that skyrocketed from mid-2020 well into 2021 have come crashing down, pulling the growth-heavy Nasdaq Composite into correction territory.
But investors hardly need to lose hope: Defensive stocks offer much more stability during volatile market environments.
- SEE MORE The 22 Best Stocks to Buy for 2022
Defensive plays boast certain characteristics. For one, they typically need to have tangible earnings and cash flow, which are used to pay dividends, buy back shares or grow businesses through the purchase of competitors. For long-term, risk-averse investors, the steady nature and compounding dividends of defensive stocks are ideal for reaching their financial goals.
Defensive stocks also typically have dominant positions in huge markets with durable competitive advantages. They also tend to be the kinds of companies whose products and services are essential to people's everyday lives; thus, their stocks tend to hold up better when the economy slows. Think consumer staples companies, who peddle canned foods, cleaning supplies and toilet paper. Or think defense contractors, whose projects last for years, sometimes decades, and face little competition given required national security clearance and sophisticated expertise.
That's why when, say, the Federal Reserve becomes more aggressive about tightening policy, like they have of late, defensive plays tend not to suffer as much. Whether rates rise or fall, people will still need paper towels, electricity and national defense.
With that said, here are six of the best defensive stocks for investors seeking protection right now. To help in our search for solid companies, we turned to the Stock News POWR Ratings system to find Buy and Strong-Buy rated names that might be better suited to help investors ride out uncertain market conditions. Check them out.
Data is as of Jan. 26. Dividend yields are calculated by annualizing the most recent payout and dividing by the share price.
- Market value: $106.5 billion
- Dividend yield: 2.9%
- POWR Rating: B (Buy)
Lockheed Martin (LMT, $391.24) is a security and aerospace company that has four segments: Aeronautics; Missiles and Fire Control; Rotary and Mission Systems; and Space. The company produces high-tech weapons and defense systems, but is best known for its F-35 fighter jets. LMT also provides a wide variety of services for governments all over the world.
Government budgets and defense spending are much less volatile than other parts of the economy. And the general trend is up; defense spending, on a global level, is expected to grow at about a 3% average annual rate through 2023 to reach $2.1 trillion, according to the Deloitte Research Center for Energy & Industrials.
They also tend to have large balance sheets and a long history of paying and raising dividends which also leads to outperformance during periods of economic turbulence. As an example, Lockheed Martin hiked its quarterly dividend by 7.7% in late 2021 to $2.80 per share. The 2.9% yield is much higher than the S&P 500's current yield of 1.4%.
Lockheed exemplifies how a defensive stock performs when the chips are down. While the S&P 500 is off by about 9% year-to-date, LMT shares boast a total return (price plus dividends) of 10%.
The company has been moving into higher-growth and -margin segments such as cybersecurity and IT services, which should help it build momentum going forward. Indeed, Lockheed is coming off a solid fourth-quarter report that saw earnings jump 17% year-over-year to $7.47 per share. Looking forward, the pros expect Lockheed's fiscal 2022 earnings to increase 16.5% YoY to $26.52 per share, then improve another 5.1% on top of that in 2023, to $27.88 per share.
LMT has an overall B (Buy) rating in the POWR Rating system. Among the reasons for this is a Quality Grade of B, which is backed up by a current ratio of 1.4, indicating that Lockheed is more than capable of tackling its shorter-term liabilities. Check out the complete POWR Ratings for LMT, including a deeper look at its component scores.
- Market value: $376.6 billion
- Dividend yield: 1.6%
- POWR Rating: A (Strong Buy)
Walmart (WMT, $135.75) is a consumer staples giant that accounts for roughly 9% of all retail sales in the U.S., according to global news and analysis firm PYMTS.com. The company was an innovator in terms of discounting and building a logistics and fulfillment behemoth that disrupted the entire industry.
These efforts have continued to this day, as evidenced by its fast-growing e-commerce business and introduction of Walmart Plus – a membership program intended to keep the company competitive with Amazon (AMZN) and other upstarts. It's also successfully expanded into groceries, which is one of the fastest-growing parts of its business.
Recent supply-chain disruptions due to the pandemic created challenges for many retailers unable to fully stock inventory, resulting in revenues falling short of their targets. However, WMT was able to evade this issue as the company chartered its own ships from Asia and put in its orders well in advance to ensure that it would be able to meet its customers' needs during the holiday season.
Walmart belongs on any short list of the market's best defensive stocks for a number of reasons. For starters, during periods of inflation, consumers prioritize value and bulk, which means the discount retailer sees more foot traffic. Similarly, it also sees increased activity during periods when the economy slows, due again to their low prices.
As a result, WMT has consistently grown its revenues, earnings, free cash flow – the money left over after a company has paid its operating expenses and capital expenditures – margins and dividends across many years. It is also why Walmart successfully navigated numerous challenges, including the Great Recession, the U.S.-China trade dispute and recent pandemic-related hurdles (e.g., supply-chain disruptions, a labor shortage).
Walmart earns an overall A (Strong Buy) grade in the POWR Rating system – the highest there is. (A-rated stocks, for the record, have delivered an average annual performance of 30.7%.)
Particularly appealing about WMT shares are its growth prospects over time, seen in its Growth Grade of B. For fiscal 2022, Wall Street is projecting a 17% increase in earnings per share (EPS) to $6.41. Additionally, analysts have an average price target of $171.19 on the Dow Jones stock, which implies 26% upside over the next 12 months or so.
WMT also has a Stability Grade of B due to its low beta of 0.48. A beta of less than 1 means that a stock is theoretically less volatile than the S&P 500. See WMT's complete POWR Ratings breakdown.
- Market value: $431.8 billion
- Dividend yield: 1.3%
- POWR Rating: A (Strong Buy)
UnitedHealth Group (UNH, $458.43) is a diversified healthcare and insurance company that offers a broad spectrum of products and services through its UnitedHealthcare and Optum platforms. The company provides employers with products and resources to plan and administer employee benefit programs.
UNH is included among the best defensive stocks because the company's revenues are ultimately tied to overall healthcare spending. This is another trend that continually rises, regardless of how the broader economy is performing. This is primarily due to an aging population, the constant innovation in new treatments and services, and increasing government support to subsidize healthcare expenditures.
It's quite staggering to think that in 1970, healthcare spending was only about $75 billion, or $356 per capita, which equated to about 7% of gross domestic product (GDP), according to analysis done by the Kaiser Family Foundation. In 2020, healthcare spending was $4.1 trillion, or about $12,000 per person, and nearly 20% of total GDP.
While these rising healthcare costs pose a significant challenge for households and governments, it benefits companies like UNH. Within the health insurance segment, UnitedHealth – which delivers healthcare through partnerships with employers and governments – is the clear leader with roughly 150 million members.
While the pandemic did pose some challenges, especially as many people lost health insurance due to changes in their employment status, the company has already put together an impressive rebound. In fiscal 2021, revenue grew nearly 12% year-over-year and operating income improved 7.1%. The company also reported having $23.9 billion in cash – up 20.8% from the year prior.
UNH is another one of the A-rated defensive stocks in the POWR Ratings universe, translating into a Strong Buy. This is in part because of the stock's relative stability compared to the markets, with a low beta of 0.64 earning it a Stability Grade of B. Get the full scoop on UNH's POWR Ratings scores.
- Market value: $37.7 billion
- Dividend yield: 0.8%
- POWR Rating: A (Strong Buy)
McKesson (MCK, $246.97) offers healthcare supply chain management, retail pharmacy, community oncology and specialty care, and healthcare information solutions globally. It has four segments: U.S. Pharmaceutical; International; Medical-Surgical Solutions; and Prescription Technology Solutions.
MCK is another good pick among defensive picks because its business is relatively unaffected by changes in economic or monetary conditions. This is because its customers are in the healthcare space and demand for these types of products and services consistently increases over time due to demographics and rising costs.
In addition, MCK offers some growth upside to investors as well given, that some of its customers are in the biotech, genomics and oncology sectors which are all accelerating at a double-digit rate.
The company's most recent earnings report was quite impressive with revenues increasing 9.5% year-over-year to $66.6 billion. Adjusted earnings were $6.15 per share, a 28% increase over the year prior. More impressively, MCK increased its earnings guidance for fiscal 2022 by about 10%. In total, the company now expects 30% annual earnings growth at the midpoint, with the main drivers being COVID-19 testing and vaccination distributions, increased sales of personal protective equipment, and profitable venture investments.
This strong performance reflects that MCK is an integral player in the healthcare space. Over the past year, healthcare spending in the U.S. has exploded due to the coronavirus, and McKesson has been a beneficiary with 30% EPS growth this year. Further, the stock remains cheap with a forward price-to-earnings (P/E) ratio of 11.6, which is about half of the S&P 500's
There are Strong Buys, and then there are Strong Buys, and McKesson is the latter. Yes, McKesson earns an A grade like most of the other defensive stocks outlined here. But what sets MCK apart is its appealing combination of high value, growth and stability marks (all B-rated). In addition to the company's strong forecast for 2022, it's trading at 11.4 times forward earnings – roughly half that of the S&P 500 – and its beta is perched at 0.80.
McKesson also earns a Sentiment Grade of A, with 12 analysts calling the stock a Strong Buy or Buy calls versus just two saying Hold and one rating it a Sell. See more of MCK's POWR Ratings.
- Market value: $63.4 billion
- Dividend yield: 1.6%
- POWR Rating: A (Strong Buy)
Northrop Grumman (NOC, $403.23) is one of the largest aerospace and defense contractors in the world with a $63 billion market cap. The company operates through four segments: Aeronautics Systems; Defense Systems; Mission Systems; and Space Systems. Its largest source of revenue is providing aircraft systems with tactical intelligence, weapon and mission systems for the military, radar, electro-optical/infrared and acoustic sensors.
NOC certainly fits the criteria for this list of the best defensive stocks as the company has consistently grown its revenues, earnings, free cash flow and dividends. Over the last five years, each of these metrics has averaged annual growth of 8.5%, 20.3%, 8.8% and 11.8%, respectively. This is because defense spending continues to grow on an aggregate level, and NOC is one of the premier stocks in the sector.
In addition to its relative stability as a defense stock, NOC does offer outsized growth potential given its exposure to the space industry. Northrop's customers include NASA and telecommunications companies, as it provides services related to space logistics, satellite launches and maintenance, space security, and propulsion systems. Overall, revenue from the space industry is expected to reach $1 trillion by 2040 from its current $350 billion, according to Morgan Stanley.
The POWR Ratings system gives Northrop Grumman an overall grade of A, which equates to a Strong Buy. NOC has a Value Grade of B as its forward P/E comes in at 16.1 – below the S&P 500's 20.3. Plus, a 17-year streak of dividend hikes earns it solid B grades for both quality and stability. Its Sentiment Grade also arrives at B thanks to a bullish-leaning Wall Street (six Strong Buys, four Holds, one Sell, one Strong Sell). Check out NOC's complete POWR Ratings.
- Market value: $138.4 billion
- Dividend yield: 2.1%
- POWR Rating: A (Strong Buy)
CVS Health (CVS, $104.86) is a pharmacy and retailer that is moving up the value chain by also offering health services. Its segments include Pharmacy Services, Retail/LTC (long-term care), and Health Care Benefits. In addition, it has roughly 9,900 retail locations, 1,100 MinuteClinic locations, and online retail pharmacy websites.
While most associate CVS with its pharmacy and retail business, its 2018 acquisition of Aetna transformed the company. While its namesake business continues to be a cash cow, it could lose traction as e-commerce sales increase and companies like Walmart (WMT) and Costco (COST) compete aggressively to win market share in the pharmacy business.
Thus, CVS is focusing on offering higher-margin services with its MinuteClinics and health insurance segments. During the coronavirus crisis, CVS has been an integral part of the healthcare solution, with its retail locations providing testing, basic care and vaccinations.
Not surprisingly, as healthcare spending explodes, CVS has seen impressive growth. In its most recently reported quarter, the company reported a 10% year-over-year rise in revenue and an 18.7% jump in earnings per share.
CVS has an overall A (Strong Buy) rating from the POWR Ratings system due in part to a Growth Grade of A. Wall Street expects the company's momentum to continue in fiscal 2022, with analysts forecasting an 8.1% rise in revenues and a 9.5% improvement in EPS.
The stock also has a Value Grade of B as it's trading at a low 12.8 times forward earnings. And 14 Buy or Strong Buy ratings from analysts compared to just four Holds and not a single Sell or Strong Sell help CVS earn a Sentiment Grade of B. See CVS's full POWR Ratings rundown.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.