Several measures indicate the U.S. economy may be near a recession. It has been seven years since the last official recession ended, which is an unusually long period of time between economic downturns.
And, the Federal Reserve has resumed monetary tightening, including raising interest rates. This could be a headwind for the prolonged rally in U.S. stock and bond markets. This has compelled many economists to believe the U.S. is overdue for a recession.
If a recession is in the offing, investors should reposition their portfolios, away from riskier growth stocks that would be vulnerable to an economic downturn. Instead, investors should put focus on high-quality dividend stocks.
The reason is because dividend stocks offer several layers of protection when stock markets decline. First, dividends are a source of real returns--the best companies keep pumping out their quarterly payments, in bear markets or bull markets.
And, high-quality businesses with competitive advantages are the types of companies that remain profitable, even during recessions. A consistent level of profitability means a company is continuing to build shareholder wealth.
Right now, the S&P 500 has an average dividend yield of 2%. The good news: it is not difficult to find blue-chip companies with dividend yields at or above the index average. Some premier dividend stocks have yields upward of 4%. While interest rates remain relatively low, these dividend yields are highly attractive.
This article will discuss the top 10 dividend stocks--in no particular order--that investors should buy to prepare for the next recession.
Recession Proof Stock #1: AT&T
While a recession would be devastating to many speculative stocks, investors can take solace in the fact that most consumers will still pay for their wireless cellular, TV and Internet service.
AT&T (T) is a Dividend Aristocrat, which are stocks in the S&P 500 with 25 or more years of dividend growth.
It has increased its dividend for 33 years in a row, and the company should have little trouble raising its dividend in the future.
AT&T's dividend represented approximately 70% of the company's free cash flow last year. This leaves plenty of room for continued dividend growth.
The DirecTV purchase made AT&T the largest pay TV provider in the world. It resulted in a global giant, with more than 26 million customers in the U.S., and another 19 million customers in Latin America.
AT&T generated $16.9 billion of free cash flow for the year, up 7% from the previous year. Adjusted earnings per share rose 5% in 2016.
The company added 9.5 million wireless customers last year, including 6.2 million in the U.S. and 3.3 million in Mexico.
Time Warner has many valuable cable and premium TV properties, including CNN and HBO. It also has a large movie studio. It has three out of the top five basic cable networks, and the No. 1 premium network.
Purchasing Time Warner would be a great diversification tool for AT&T. It would allow AT&T to expand into media. The combination would result in a giant company, with 133 million nationwide mobile and 25 million video subscribers.
AT&T has a 4.8% dividend yield, which is more than twice the average dividend yield of the S&P 500.
Recession Proof Stock #2: Johnson & Johnson
J&J (JNJ) has a very long history of dividend growth. It is one of only 19 Dividend Kings, a list of stocks that have 50 years of consecutive dividend growth under their belts.
To see the complete list of Dividend Kings, click here.
It has maintained such an impressive track record, because of its excellent brands. Some of its popular consumer brands include Johnson's, Neutrogena, Listerine and Tylenol. J&J has three large businesses--pharmaceuticals, medical devices and consumer health care products--that collectively generated $15 billion of free cash flow in 2016.
All three operating segments posted sales growth last year, after adjusting for the U.S. dollar. Operational sales growth was as follows:
- Pharmaceuticals: Up 7.4%
- Medical Devices: Up 0.9%
- Consumer Health: Up 1.5%
Total revenue grew 3.9% for the year, to $71.89 billion. Excluding all nonrecurring items, full-year sales growth was 7.4% worldwide, including 8.9% in the U.S., and 5.7% outside the U.S. Earnings-per-share rose 8.5% on an adjusted basis last year. On an operational basis, earnings-per-share increased 9.4%.
These are very strong growth rates, and were largely due to J&J's pharmaceutical segment, led by oncology and immunology. In oncology, multiple myeloma drug Darzalex reached more than $500 million in sales in its first full year on the market. Sales stand to grow much higher moving forward, since J&J recently received approval for two additional lines of the drug. Another strong performer last year was Imbruvica. Worldwide sales soared 84% in 2016, to $1.25 billion.
In immunology, sales of Stelara rose 31% last year, to $3.23 billion. J&J's future growth will be comprised of its strong pharmaceutical pipeline, and acquisitions. In 2017, J&J acquired Actelion for $30 billion. Actelion is an R&D company which focuses on treating pulmonary arterial hypertension.
Earnings are likely to grow at a mid-to-high single-digit rate going forward, which will be more than enough growth to continue increasing the dividend each year.
Recession Proof Stock #3: Coca-Cola Co.
Coca-Cola (KO) is a global beverage behemoth. It owns or licenses more than 500 brands, which are sold in more than 200 countries worldwide. Its portfolio includes 20 individual brands that bring in at least $1 billion in sales each year.
And yet, Coca-Cola is struggling. The reason is because Americans are drinking less soda. In 2015, soda consumption fell to a 30-year low in the U.S. The decline in soda consumption has caused Coca-Cola's financial performance to stagnate.
Sales have fallen every year for the past five years. In 2012, Coca-Cola generated total revenue and net income of $48.02 billion and $9.02 billion, respectively. Last year, sales and net income fell again, to $41.86 billion and $6.53 billion. Earnings-per-share declined 24% from 2012 to 2016.
In response to the changing beverage landscape, Coca-Cola has branched out into still beverages, such as water, juices and teas. It has a large portfolio of popular brands in these areas, including Dasani, Minute Maid, Simply Orange, Honest Tea, Odwalla and more. These products are performing well--still-beverage volume rose 3% for the year.
The problem Coca-Cola is having with this strategy is that its flagship soft drinks such as Coca-Cola, Diet Coke and Sprite continue to make up the majority of the company's profits. Sparkling beverages--ready-to-drink carbonated beverages--represented 72% of the company's worldwide case volumes last year, down just one point from the previous year.
Coca-Cola still has two major advantages: pricing power and international growth. The company's price/product mix shift boosted revenue by 6% last year. And, organic revenue rose 12% in Latin America, and 3% in Europe, the Middle East and Africa.
A world-class distribution system and pricing power allows Coca-Cola to generate huge free cash flow, even though sales are declining. Last year, Coca-Cola had free cash flow of $6.53 billion. This more than covers its dividend. In 2016, the company returned $6 billion in dividends.
Coca-Cola has increased its dividend for 55 years in a row, including a recent 6% increase. The new annualized dividend rate of $1.48 per share provides a 3.4% dividend yield.
Recession Proof Stock #4: PepsiCo
PepsiCo (PEP) is very much like Coca-Cola, in that it is a huge soda company. However, PepsiCo offers the added bonus of diversification. In addition to its beverage business-which includes sparkling and non-sparkling beverages like Pepsi, Mountain Dew, and Gatorade-PepsiCo has a large food business.
PepsiCo operates Frito-Lay snacks, as well as Quaker. It also has healthier snack brands such as Sabra hummus and Naked juices. Sabra generates roughly $800 million in annual sales, while PepsiCo management expects Naked to be its next brand to reach $1 billion in annual sales.
PepsiCo's sales are divided almost equally between food and beverages. Its diversification is highly valuable, given the declines of soda consumption in the U.S. Thanks largely to its food business, PepsiCo's currency-neutral revenue rose 4% last year.
Cost cuts helped drive 9% earnings growth in 2016. Earnings per share, adjusted for non-recurring items, increased 15% in the fourth quarter.
PepsiCo generated $7.4 billion of free cash flow last year. The company's adjusted return on invested capital was 21.5% last year, which is well above its cost of capital. Such strong cash generation allows the company to return lots of cash to shareholders.
PepsiCo is a very strong dividend growth stock. It has hiked its dividend for 45 years in a row, including a recent 7% increase for 2017. The company expects to return $6.5 billion to shareholders in 2017, made up of $4.5 billion of dividends, and $2 billion of share repurchases.
PepsiCo expects to generate another $7 billion of free cash flow in 2017. Earnings, adjusted for currency fluctuations and one-time expenses, are projected to rise 8% this year.
The company is being negatively impacted in the short-term by the strong U.S. dollar. But, its international exposure is a long-term catalyst. PepsiCo's growth will be fueled by international markets, particularly under-developed economies. Last year, the company grew organic revenue by 9% in Latin America, and 5% in Asia, the Middle East, and North Africa.
For a head-to-head matchup of Coca-Cola versus PepsiCo, click here.
Recession Proof Stock #5: Hormel Foods
Hormel (HRL) is a diversified food company. Its refrigerated foods business represents nearly half of its profit. Some of Hormel's core brands are Jennie-O, Spam, Dinty Moore and Skippy. Hormel is adept at making accretive acquisitions. It seeks high-quality brands with leadership positions in their respective categories, that it can leverage with its distribution capabilities.
This provides for significant cost synergies, which results in sales and earnings growth. For example, last year, Hormel increased sales by 3%, and earnings-per-share by 29%. The strong results continued in the first quarter of 2017, when Hormel produced a record for earnings-per-share. Revenue increased another 3%, along with 2% earnings growth year over year.
Hormel's major acquisitions in the past few years, have revolved around the strategic desire to enter new product markets. Specifically, Hormel is ramping up its exposure to natural foods and organics. Its recent deals include:
- 2016 acquisition of Justin's, maker of natural nut-butter products.
- 2015 acquisition of Applegate Farms, maker of natural and organic meats
- 2014 acquisition of CytoSport, nutritional products company
Those acquisitions helped diversify its brand portfolio. Hormel's overall results are being negatively affected by falling poultry prices, which is a headwind for its large Jennie-O segment. But, this is likely to be a short-term fluctuation.
The long-term health of the company is very strong. Because of its strong brands, profitability, dividend track record, and growth potential, Hormel ranks very highly using the 8 Rules of Dividend Investing. Hormel recently raised its dividend for the 51st year in a row. It joins many other stocks on this list as among the 19 Dividend Kings.
Its next quarterly dividend will be its 355th dividend payment to shareholders. And, its dividend growth is very impressive. For example, last year's increase was a 17% raise. Hormel has a 2% dividend yield, which is in-line with the average yield in the S&P 500. However, it makes up for an average dividend yield with very high dividend growth.
Recession Proof Stock #6: Consolidated Edison
ConEd (ED) makes the list because it is a utility stock. Utilities are among the best performers when a recession hits because their businesses are hardly affected.
Everyone needs to keep the lights on, no matter the condition of the economy. Plus, the utility business model is augmented by being a regulated industry. ConEd receives periodic regulatory approval to raise rates. Along with population growth, this virtually ensures a modest amount of revenue growth each year.
This provides utilities with consistent profits from year to year, no matter what. ConEd operates mostly in the Northeast. It has over 3 million electricity customers in New York.ConEd had earnings of $4.15 per share in 2016, up 2% from the previous year.
Trends improved as 2016 drew to a close. Earnings, as adjusted for non-recurring items, rose 13% in the fourth quarter. For 2017, the company forecasts earnings, as adjusted, to be in a range of $3.95 to $4.15. The middle of the guidance would represent a 2% growth rate from 2016.
One potential risk for ConEd moving forward is rising interest rates. Utilities have relatively high levels of debt in their capital structures. Higher interest rates are likely to increase ConEd's cost of capital. Fortunately, the company has a strong financial condition. ConEd holds a 'BBB+' credit rating from both Standard & Poor's and Fitch. It receives a stable outlook from all three major credit rating agencies.
And, earnings should remain stable, and grow modestly each year. A reasonable assumption for a large utility's long-term earnings growth is 1% to 2% above the rate of GDP. Utilities are a highly saturated industry, but can still grow from higher rates, population growth and cost improvements.
Its comfortable financial position means the company should continue to generate more than enough earnings to support its dividend. ConEd has increased its dividend for 42 consecutive years, including a 3% raise for the first-quarter 2017 payment.
In fact, ConEd is the only electric utility included on the list of Dividend Aristocrats. Investors can expect the company to raise its dividend at or near the rate of earnings growth, around 2% to 4% per year. The stock has a current annualized dividend yield of 3.5%.
Recession Proof Stock #7: McDonald's
McDonald's (MCD) is a fast food goliath, with 36,000 restaurants, in over 100 countries around the world. Over the past few years, McDonald's has embarked on a major turnaround. The company's sales had fallen as it lost customers to competitors in the quick-service restaurant space.
In response, the company re-dedicated itself to renovating its restaurant, closing under-performing locations, and lowering costs. McDonald's also moved to more quickly respond to what its customers wanted. Specifically, McDonald's unveiled All-Day Breakfast, and a reshuffled value menu.
This renewed focus paid off. In 2016, earnings-per-share rose 13%, or 16% when excluding the impact of foreign exchange translations. Going forward, McDonald's recently announced a new three-year global growth plan, to continue its momentum.
Among its strategic initiatives, are improvements in quality, convenience and value. This means a continued emphasis on improving its ingredients, reducing customer wait times and keeping prices low. In addition, McDonald's will be enhancing its digital capabilities in a big way.
Inside the restaurant, McDonald's will be rolling out kiosks to place orders. This will allow for greater convenience and personalization for its customers, and means no longer standing in line. The food is brought directly to the table.
Outside the restaurant, McDonald's has created an app that customers can use to place orders, while skipping the drive-thru line. Instead, customers will be able to choose curbside delivery, which will help speed up the ordering process. McDonald's expects mobile order and pay functionality in 20,000 restaurants by the end of 2017.
These are all positive steps to restore traffic. And, McDonald's is a good pick for a recession. Consumers tend to scale down their spending on eating out when the economy enters a downturn. In fact, McDonald's was a very strong performer during the Great Recession. In 2008, McDonald's earnings-per-share grew 26%. It followed this up with 8% growth in 2009.
As a result, McDonald's is a natural pick for a recession-resistant portfolio. It is also a steady dividend stock. McDonald's is a Dividend Aristocrat. It has raised its dividend every year since it made its first dividend payment to shareholders in 1976. It has a current dividend yield of 2.9%.
Recession Proof Stock #8: Wal-Mart
Outside the utility sector, Wal-Mart (WMT) is arguably the most defensive, recession-resistant stock an investor can find. Wal-Mart and McDonald's were the only two stocks in the Dow Jones Industrial Average, that saw their share prices increase in 2008. There is good reason for this-investor demand for these stocks actually rises when economic times are tough.
Wal-Mart is the world's largest retailer. It is a discount retailer, and thanks to its unparalleled retail distribution system, it is very hard for competitors to match its prices. The company actually benefits from economic uncertainty, because consumers typically scale down their spending during recessions.
Instead of shopping at higher-priced department stores, consumers will often shift down to discount retail. Consider Wal-Mart's performance during the Great Recession:
- 2007 earnings-per-share of $3.16
- 2008 earnings-per-share of $3.42 (8.2% growth)
- 2009 earnings-per-share of $3.66 (7% growth)
- 2010 earnings-per-share of $4.07 (11% growth)
Wal-Mart sailed through the last recession. However, Wal-Mart's earnings have declined in recent years, which has forced the company into a turnaround. Going forward, Wal-Mart is making major investments in its e-commerce platform, to better compete with online retailers.
Wal-Mart expects to spend around $11 billion during the current fiscal year, to continue renovating its physical stores, and building its e-commerce business. This investment is possible because Wal-Mart is highly profitable. In the last fiscal year, it had profit of $13.6 billion. Elevated spending will likely result in another year of declining earnings.
That said, the investments are already paying off-for example, Wal-Mart's e-commerce sales rose 29% last quarter. Total companywide sales increased 3% on a currency-neutral basis, to $497 billion. Wal-Mart generated $31.5 billion of operating cash flow last fiscal year. It returned $14.5 billion to shareholders, in dividends and share buybacks.
Wal-Mart stock has a 3% dividend yield, and the company has raised its dividend for 44 years in a row.
Recession Proof Stock #9: Procter & Gamble
Similar to Wal-Mart, P&G (PG) is also engaged in a large turnaround. P&G's growth slowed down over the past several years. In response, it has gone through a massive restructuring of its brand portfolio. The company decided to sell off low-growth brands, so that it can focus on its higher-growth product categories.
Its major transactions include the sale of the Duracell battery business to Warren Buffett's Berkshire Hathaway (BRK.B) for $4 billion. Later, P&G divested its beauty brand portfolio to Coty (COTY) for $12 billion.
Going forward, the company will be much more streamlined and focused. Its portfolio will revolve around 60-plus brands in 10 categories. It has retained most of its flagship brands, including Tide, Gillette, Old Spice, Charmin, Bounty and more. The best-performing category for P&G right now is health care. Segment sales rose 7% last quarter.
The over-arching goal of the massive round of divestitures, was for P&G to become more efficient. The early results are encouraging--P&G's currency-neutral earnings increased 9% last quarter.
For the full fiscal year, P&G expects currency-neutral sales to increase 2% to 3%. Cost cuts and share repurchases are expected to contribute to growth--P&G expects fiscal 2017 earnings to grow in the mid-single-digit range.
P&G's strong brands and highly profitable business model allow the company to pay steady dividends. It has paid a dividend for 127 years in a row, ever since the company was incorporated, all the way back in 1890. And, it recently raised its dividend by 3%. This was an acceleration from the previous year's 1% dividend growth rate, reflecting the success of the huge portfolio restructuring.
P&G has now come through with dividend hikes for 61 years in a row. It is a Dividend King. On an annualized basis, P&G's new dividend rate is approximately $2.76 per share. This amounts to a 3% dividend yield.
Recession Proof Stock #10: General Mills
General Mills (GIS) is a food giant. It has a large portfolio of packaged and refrigerated foods, including several cereal brands, as well as Yoplait, Pillsbury, Betty Crocker and Progresso. The company has encountered challenges recently, due to declines in its cereal and soup businesses. General Mills' cereal business is among its most important segments.
It seems that consumers are moving away from cereal and canned soup. Also, its yogurt business is under intense competitive pressure from Greek yogurt brands like Chobani. This caused General Mills' sales to decline 6% in fiscal 2016. Excluding the impact of the strong U.S. dollar, currency-neutral revenue fell 2% for the year.
Conditions have not improved this year. Last quarter, currency-neutral sales fell 5%. Sales have also fallen by 5% over the first three quarters of fiscal 2017. Through the first nine months of fiscal 2017, sales in the North America Retail segment fell 8%, due mostly to declines in meals and baking foods, and yogurt. Segment-operating profit fell 5% in this time, due to lower volumes.
General Mills is hoping to fuel a sales turnaround with natural and organic foods. The company has significantly built this business in recent years, largely through acquisition.
For example, in 2014 General Mills acquired natural food company Annie's, for $820 million. Led by Annie's, General Mills' natural and organic portfolio is growing at a double-digit rate. It is expected to reach more than $1 billion in sales this fiscal year.
In the meantime, the company is highly profitable. Stability is a benefit of operating in the food industry. This allows General Mills to reward shareholders with steady dividends each and every year. General Mills has made dividend payments to shareholders, without interruption, since 1925.
And, it has increased its dividend for more than a decade. General Mills has a current dividend yield of 3.3%. It is a Dividend Achiever, which is a group of 265 stocks with 10-plus years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
Trending news on TheStreet: