3 Defensive Dividend Stocks For Tough Times

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 |  Includes: LNT, PG, VZ
by: Mark Bern, CFA

By Mark Bern, CPA CFA

Why do I care about buying defensive stocks right now? I believe it is prudent to take a more defensive position when there is so much uncertainty in the economy. Plain and simple, we do not know how much collateral damage may occur to U.S. financial institutions or to the global economy if the problems of Europe swell and become unmanageable.

In the case of one sovereign default, the impact may be muted. If the European banks are in as bad shape as some suggest, the need to support the banks may bring additional nations’ sovereign debt issues under greater scrutiny (more downgrades) and raise the cost of financing to unsustainable levels causing more defaults.

It is the later scenario that we should be preparing against. If it never happens, though, we’ll still be okay because we will be looking at strong, dividend-paying stocks with some appreciation potential that, as conservative, income-oriented investors, we would be considering even in good economic circumstances.

What characterizes a defensive stock? Defensive stocks include those companies that offer products or services considered essential in any economic environment. I consider groceries to be pretty defensive, as well as utilities. Most people won’t consider cutting off phone service, and most people will continue to eat, bathe, and brush their teeth (I hope).

People don’t always continue to pay their mortgage or rent, as we have seen resulting from the Great Recession. They may move in with friends or parents. Utility bills will go down at the previous address, but rise at the new one. The rise will be less, but impact is muted.

Most people will continue to address health issues and take prescribed medications. They may not eat out as much, but if they do they will probably eat at less expensive venues. And finally, people will be more likely to shop for bargains at sales and discounters.

So, from the above assumptions we can begin to perceive which companies are likely to see revenues drop less than the average: grocers, certain producers of consumer products that are generally used daily, electric utilities, water utilities, discount retailers, wireless communications service providers, healthcare providers, and low-cost restaurants.

What we saw in the Great Recession should give us some clues. We saw retail sales plummet, but discounters such as Wal-Mart (NYSE:WMT) actually gained market share as more people were forced to spend less on everyday items. More people ate at McDonalds (NYSE:MCD) as well. Healthcare, as a whole fared better than most industries. Consumer products manufacturers, like Procter & Gamble (NYSE:PG) saw minuscule, temporary drops in revenue.

I am only going to write about three companies at this time, but I’ll try to bring you more in the near future. I will start with one utility, one consumer products company, and one wireless communications company. As I add more companies in future articles, I will try to bear in mind the need to keep portfolios diversified.

If you already have a good entry in one or more categories, you can disregard the ones I suggest. If, however, you do not have exposure in a category covered here or in future articles, may I suggest that you use these companies as a place to start consideration to plug those gaps and prepare for whatever comes.

Verizon (NYSE:VZ) is a diversified telecommunications company with the largest wireless 4G network in North America covering approximately 290 million people. The company has a wire-line presence in 28 states and the District of Columbia and is the largest provider of print and on-line directory information.

Honestly, I would normally choose AT&T (NYSE:T) for this article, but because of the $4 billion of costs pending in relation to the company’s failed attempt to acquire T-Mobile, I would hold off until the consequences of the ongoing saga is fully reflected in the price.

At the current price (at the close on Friday, December 12, 2011) of $38.35, VZ’s $2.00 annual dividend yields 5.2 percent. The company has raised its dividend in each of the past five consecutive years. For more information about VZ, please consider this focus article.

Procter & Gamble sells its products in more than 180 companies around the globe and more than 45 percent of revenue comes from outside the U.S. with that percentage continuing to grow as hundreds of millions of new consumers are entering the middle class. The company has an S&P credit rating of AA and pays a dividend of 3.2 percent based upon the current price of $64.31 (as of the close on December 12, 2011). O

ne of the most important features offered by PG is its consistency: 55 consecutive years of dividend increases! For additional information on PG please consider the focus article here.

Alliant Energy (NYSE:LNT) supplies electricity, gas, and other related services in Wisconsin, Iowa and Minnesota. The current dividend is $1.70, yielding 4.0 percent at the current price (as of the close on Monday, December 12, 2011) of $41.70. This utility has regulated utilities plus a non-regulated unit, RMT which provides siting, permitting, engineering and construction services to the renewable energy industry.

Much of what I like about this company is the relative safety of the dividends which have increased for eight consecutive years and the potential dividend increases that I expect to average close to six percent per year going forward. That rate is significantly higher than the industry average. For additional information on LNT please consider this focus article.

Company

Symbol

Current Price

Current Yield

TTM Total Ret.

Est. Ave. Total Ret.

Verizon

VZ

$38.35

5.2%

18.6%

13%

Procter & Gamble

PG

$64.31

3.2%

5.1%

14%

Alliant Energy

LNT

$41.70

4.0

19.2%

9%

Click to enlarge

If purchased in equal amounts, the three stocks combined would provide an average current yield of 4.1 percent and an estimated long-term average future total return of 12 percent. But possibly more important, sticking with the defensive theme, these three companies could reduce downside exposure in the next recession. You remember -- those ugly things that occur about every four years on average, and the last one happened in 2009? The problem is that since 1982 we’ve only experienced three real recessions. Will the averages catch up with us by more frequent recessions? All I can say is: Be prepared.

Disclosure: I am long T, PG.