The summer of extreme heat is upon us, and it's not just because of the temperatures sweeping the nation. Inflation has been running hot since the start of the new year. CPI is up to 9.1%, and concerns about another hawkish increase have investors concerned, especially since June’s 75-basis point hike was the largest jump since 1994.
Following Jerome Powell reversing course from a 50-point hike to a 75-point hike and then the Bank of Canada’s recent surprise 1% hike, the nagging reality is that anything is possible and Central Banks are starting to throw in the kitchen sink.
A Bloomberg survey of economists believes that we’ll see another 75-basis point hike to try and curb inflation. Whatever the decision, it's crucial that investors consider well-established companies that provide consistent returns no matter the business or market cycle. Defensive stocks can provide peace of mind, offering consistent dividends and stable earnings regardless of investor sentiment. As a result, we are focusing on three defensive stocks in different sectors to consider for a portfolio: healthcare, consumer staples, and REIT.
With several risks that have investors concerned in a rising interest rate environment, amid geopolitical concerns threatening economies and thus investments, investors are selling out of interest rate-sensitive stocks and turning to defensive stocks that offer better performance, security, and returns. And while the performance in defensive sectors may not be as robust as growth stocks over the last decade, or those that have experienced substantial price increases this past year, defensive stocks tend to be solid investments and protect returns during periods of volatility. Not only are they portfolio diversifiers, but as you can see in the chart below, the three stocks I’ve selected, MRK, CALM, and ADC, have significantly outperformed the S&P 500 YTD.
Using the stock screener tool and sorting by my preferred defensive sectors, strong buy ratings, and a minimum $1B market capitalization, I’ve identified some of the best defensive stocks according to quant ratings that should protect returns in a market decline. While there may still be some downside as the Fed raises rates, for now, these stocks come at an attractive inflection point, assuming you're willing to accept some further volatility over the short term. If so, here are two of my top REITs, according to the quant ratings.
Even during hard times or during a recession, companies that offer products and services considered necessary or required are considered defensive. Hospitals, pharmaceuticals, and insurance are characterized as having defensive growth, so I’ve selected Merck & Co., Inc. (NYSE:MRK) as the first stock pick.
Market Capitalization: $227.87B
Quant Rating: Strong Buy
Quant Sector Ranking (as of 7/25): 6 out of 1157
Quant Industry Ranking (as of 7/25): 2 out of 225
Merck & Co., Inc. is one of my top-ranked healthcare stocks operating pharmaceutical and animal healthcare divisions. It offers an array of drugs with strong patent protection, including its cancer vaccine Gardasil and an immuno-oncology drug called Keytruda.
In addition to its mission of helping people and animals, MRK has tremendous fundamentals and comes at a discount. With an overall C Valuation grade, the stock’s forward P/E ratio is 14.66x, -45.08% difference to the sector, and it has a forward PEG ratio of 1.06x, -45.32% to the sector.
Year-to-date, the stock is +17%. As evidenced by its A+ momentum and quarterly price performance above, Merck & Co. is on a bullish trend, gradually increasing its price performance and outperforming its sector median peers.
MRK is poised for growth and raised its full-year guidance between 17% and 19% after beating first-quarter EPS of $2.14 by $0.31 and revenue of $15.90B by nearly 32% year-over-year. With a diversified pipeline of vaccines and divisions, its oncology and cell therapy revenues are in tremendous shape, along with their financials. Despite Merck’s Keytruda drug losing exclusive patentability in 2029, it's still generating $17B annually. Check out its latest profitability grades below, which showcase a $16.64B cash hoard and A+ overall grade.
MRK’s gross profit margins outperform its sector peers, with a 3.06% dividend yield and attractive dividend grades that include 32 years of consecutive dividend payments. We understand why the company’s executive team remains confident in its growth drivers and outlook. MRK will report its latest earnings this week, and since Q1, the executive team indicates they have experienced double-digit growth. With a vast pipeline of products, company President and CEO Rob Davis discusses what is driving growth at the Goldman Sachs 43rd Annual Global Healthcare Conference.
“And if you look at what's really driving that growth, there continues to be our growth drivers are all really hitting on all cylinders, starting with KEYTRUDA and what we're seeing in the oncology space, Lynparza, Lenvima. Obviously, Gardasil continues to just do extremely well…we expect to see eight potential approvals by 2030, sales in excess of $10 billion by the mid-point of the next decade. So a lot of opportunity there, continuing to see a lot of great opportunity in our vaccines business with the pneumococcal disease, with what we see in RSV, Dengue, a lot of growth that’s going to continue to come in that space.” -Davis
Despite the healthcare industry's challenging market environment and circumstances, Merck showcases how it can grow and be profitable, benefiting despite a market downturn. Pharmaceutical stocks have historically shown resilience during periods of volatility. Here is a list of Top Pharmaceutical stocks that may also perform well in the current environment. The next defensive sector is consumer staples.
Even during market downturns and recessions, consumer staples do not take a significant hit when people have less money to spend because they are not the products people stop buying when money is tight. People require food and hygiene products – the necessities. As such, our next stock is Cal-Maine Foods, Inc. (NASDAQ:CALM).
Market Capitalization: $2.64B
Quant Rating: Strong Buy
Quant Sector Ranking (as of 7/25): 1 out of 187
Quant Industry Ranking (as of 7/25): 1 out of 56
I wrote about Cal-Maine Foods as a Top Consumer Staple Stock for a recession on June 2nd at $48 because as consumer prices rise, stock prices tend to follow, and food and beverage essentials tend to make safer investments during periods of high volatility. The stock is now $56.85, and the Quant rating is still Strong Buy. As inflation has surged, some food producers have benefited and are raking in the dough.
Together with its subsidiaries, CALM produces, grades, and supplies eggs for popular brands like Egg-Land’s Best and Land O’Lakes eggs. Egg prices have been among some of the biggest price increases amid inflation and bird flu cases, prompting more than a 23% increase in April for a dozen eggs.
Costs are being passed off to consumers, and people are willing to pay outrageous prices. This jump has resulted in tremendous momentum and record net income for the company, as recorded in its latest earnings report. Let’s dive in.
Despite an increase in feed and labor costs, CALM has done a great job in offsetting those costs by passing them on to consumers. Posting record net income for fiscal Q4 2022, for a total of $110M, the stock inched 2.24% higher following the announcement. With an EPS of $2.25, which beat by $0.32, and revenue of $592.96M, which beat by nearly 70%, a figure $16.9M above consensus, CALM is a strong buy to consider for portfolios.
“We continue to perform at the top of our industry as an efficient operator, despite inflationary market conditions in North America and economic uncertainties globally…We have built an exceptional management team that drives our commitment to be the most reliable producer and distributor of fresh shell eggs and egg products in the United States.” -Dolph Baker, CALM CEO.
The results have translated into a Q4 capital project to expand its cage-free production capabilities and a cash dividend of approximately $0.75 per share. Four analysts have provided FY1 Up revisions within the last 90 days, and the stocks’ momentum continues its upward trajectory.
Despite CALM’s C valuation, it still comes at a relative discount, with a trailing 0.02x PEG that’s a -94.45 difference to the sector and a forward EV/EBIT -53.57%.
On a bullish trend over the last year, +50% YTD and +62% over one year, as evidenced by the above momentum grade, CALM substantially outperforms. Because inflation is weighing on earnings power, CALM is passing off increasing feed, packaging, and delivery costs to consumers. CPI jumped to 9.1%, and with eggs having some of the highest inflation markups, CALM maintained its #1 shell egg producer and distributor position, capturing 19% of the market share and continues to see stellar growth and profits. Cal-Maine Foods is a specialty food producer. Here is a list of Top Consumer Staples Stocks for greater diversification.
With recession fears continuing to mount and tremendous growth metrics and tailwinds, stocks in the food sector, especially those produced in high volumes and used daily like eggs, are a great consideration for investment.
Real Estate and REITs generally can be considered recession and inflation-resilient, as they tend to be lower volatility if you’re able to maintain a steady income stream. People always need shelter, and in the case of my REIT pick, Agree Realty Corporation (NYSE:ADC) primarily engages in acquiring and developing properties net leased to big retailers that offer consumer staples and essentials considered defensive. ADC’s tenants include Walmart, Dollar General, and other notable names, as showcased in the image below.
Because of their high occupancy rate located in prime locations, I find this investment very attractive.
Market Capitalization: $5.74B
Quant Rating: Strong Buy
Dividend Yield (FWD): 3.68%
P/AFFO (FWD): 19.54
ADC has been successful through rent escalations and rising real estate values, especially in this environment. With a diverse offering and varying tenants, REITs tend to be benefactors in this rising rate environment, especially given ADC’s tenants tend to have ground leases which usually average 50 to 99 years. With tenants like Walmart, Home Depot, and other big box names that tend to rent for decades, ADC’s rent checks aren’t likely to bounce or turnover any time soon! With confidence in its steady income stream, let's dive into its high occupancy ratios, resulting in a great balance sheet and cash flow.
ADC’s diverse tenant holdings and geographic locations allow it to take advantage of the rising rate environment. Not only did ADC beat recent earnings, but it’s also beaten 11 of the last 12 bottom line results. ADC’s overall growth grade is a B+ with a 3-year AFFO growth of 7.44%. Recent Q1 FFO of $0.97 beats by $0.04, and revenue of $98.32M beat by $0.84M.
The company’s success has allowed it to acquire 106 properties during Q1 and +43 tenants in 20 distinct sectors, including leading operators in farm and rural supply, dollar stores, home improvements, and general merchandise, which should stand to benefit from the current environment.
With inflation expected to persist and ADC’s “fortress” balance sheet, Joey Agree, company CEO, states:
“Given our significant acquisition activity in the first quarter and robust pipeline, we are increasing our full-year 2022 acquisition guidance to a range of $1.4 billion to $1.6 billion, representing a 25% increase at the midpoint. While the midpoint of our increased acquisition guidance would represent record volume for our company, we have not and will not sacrifice quality or yield. We continue to believe that retailers dynamically evolving, and we remain intent on investing in those retailers best positioned to succeed in an omnichannel and dynamic world.”
With tailwinds that should continue positioning ADC well to capitalize in the current and future environment, the company also offers attractive dividend metrics. ADC offers a steady stream of income to its shareholders by offering a 3.86% forward dividend and recently declaring an increased dividend of $0.234. During Q1, the company’s monthly dividend saw a 9.7% increase over its annualized dividend from the previous year. Not only does the company’s balance sheet look fantastic, the company still comes at a relative discount with stellar momentum.
ADC has a C- valuation, and while the overall valuation indicates the stock is undervalued, its trailing P/AFFO of 20.88x is a 19.63% difference to the sector, an indication the stock trades at a premium. Although the stock is trading at all-time highs, given its bullish momentum and tremendous fundamentals, still maintains that it is trading at a discount with ample room for continued growth.
Over the last five years, ADC’s share price has been on an uptrend, +61%. As evidenced by the A+ momentum grade, the stock performs well with gradual increases quarterly, outperforming its sector peers. Given ADC’s strong characteristics, I believe it will continue to be a strong buy into the future, and as iREIT on Alpha and Seeking Alpha Marketplace author Brad Thomas writes:
“Agree Realty checks just about all our boxes when it comes to quality metrics…While shares don't appear to be cheap at the moment, this stock constantly remains on my watchlist. Anytime it falls below our fair-value estimate, we're pleased to pick up shares of this potential low beta/defensive income-oriented play…Our bottom-line opinion: This is an easy stock to buy and hold for those looking to sleep easy at night by keeping it simple with blue-chip dividend growers.”
Despite economic uncertainty, defensive stocks in the healthcare, consumer staples, and real estate sectors can serve as defenses and inflationary hedges. These sectors are essential, as people require products and services for their health and well-being, food items, and the real estate that supplies them. My stock picks MRK, CALM, and ADC offer strong growth traits, elements of sustainable profitability, solid valuation frameworks, and solid returns amid rising interest rates. Year-to-date, all three stock prices are positive. Considering the S&P 500 is down 17%, and each stock has a strong dividend safety rating, these three picks look very attractive. All three come at a discount and benefit from rising prices, possessing excellent fundamentals and bullish momentum.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.