With the stock-market volatility elevated and the economy looking fragile, dividend stocks represent an attractive safety play.
These equities can provide steady -- sometimes increasing – income and offer the potential for capital gains. The S&P 500 Dividend Aristocrats index has slipped 6% year to date, compared with a 17% loss for the S&P 500.
“Dividend themes are among the most defensive strategies in a late cycle/recessionary environment,” Wolfe Research analysts wrote in a commentary
They cited three themes for choosing dividend stocks.
- Dividend Aristocrats. “Companies that have consistently increased their dividends for about 25 years or more [represent] our favorite dividend investment strategy in a late cycle/recessionary environment,” the analysts said. “Such stocks carry the highest dividend yield among our favorite strategies (2.3%) and are still modestly cheap relative to their pre-2020 valuations.” These stocks have historically outperformed heading into and out of recessions.
- Dividend Yield. The analysts recommend buying stocks with yields in the second quintile of dividend stocks. “Overall, the second highest quintile of dividend-yielding stocks [has] performed better than the top quintile … over the [economic] cycle,” they said. “This is even more important later cycle, as investors worry about potential dividend cuts from the highest yielders.”
- Dividend Growth. “High dividend-growth stocks have outperformed historically,” the analysts said. “In a late cycle environment, dividend growth becomes scarce and companies with a combination of high free cash flow yield and dividend growth have materially outperformed.” Further, “the market looks for cash flow to support future dividend growth,” they said. “Dividend growth stocks are modestly cheap relative to history.”
The analysts created a list of top dividend stocks. They screened for companies that have beaten Wall Street estimates for revenue and profit, ones whose stocks have risen for two straight quarters and ones that fit at least two of the three themes cited above.
The winners include:
- Starbucks (SBUX)
- PepsiCo (PEP)
- Archer-Daniels-Midland (ADM)
- Marathon Petroleum (MPC)
- Goldman Sachs (GS)
- CVS Health (CVS)
- UnitedHealth (UNH)
- Eaton (ETN)
- Automatic Data Processing (ADP)
- Cigna (CI).
Morningstar's Take on Starbucks
“The firm’s attention to premium-quality coffee distinguishes it from chained competitors, alleviating pressure from quick-service peers and at-home consumption while underpinning substantially higher pricing for what has historically been a commoditized product,” wrote Morningstar analyst Sean Dunlop.
“This positioning looks increasingly important moving forward, as both vending and single-serve coffee machines continue to improve at the lower end of the market.”
The analyst gives the Seattle coffee-bar giant a wide moat -- competitive advantage -- and sets fair value at $106 a share. That's 7.6% above recent trading at $98.44.
Morningstar's Take on PepsiCo
Management has “righted PepsiCo’s ship, even amid covid-19-related disruptions and inflation,” wrote Morningstar analyst Dan Su.
“But there is more room to go, as the firm benefits from secular tailwinds in the snack business, growth initiatives in select attractive beverage sub-categories (energy drinks, for one) and regional markets (Africa, Asia Pacific), and an integrated business model."
The analyst gives the Purchase, N.Y., drinks-and-snacks giant a wide moat -- competitive advantage -- and sets fair value at $170 a share. That's 6.3% below recent trading at $181.42.
The author of this story owns shares of Starbucks, PepsiCo, Goldman Sachs, UnitedHealth and Eaton.
