By Tom Hutchinson, Chief Analyst, Cabot Dividend Investor
The good times appear to be rolling again. But a look under the hood reveals a less positive situation. The YTD rally is incredibly thin. In fact, just 10 stocks, almost all large-cap technology stocks, account for all the index gains. The other 490 stocks on the S&P 500 index have collectively gone nowhere.
It’s a precarious situation. The same handful of stocks can’t pull the market higher alone for long. Either this rally broadens out or it peters out. Either scenario should bode well for defensive stocks.
The market has overwhelmingly favored growth stocks and has not been kind to defensive stocks in the first half of the year. Utilities, Health Care, Consumer Staples, and Energy have been the worst-performing market sectors this year. But that situation is unlikely to persist.
There is still lots of risk. Inflation could be stickier, and the Fed could be more hawkish than currently anticipated. Most economists are still predicting a recession later this year or early next year. Even if a recession never happens, it’s reasonable to expect that the economy will slow in the second half of the year. And overall market earnings have already contracted for the last two quarters.
The relative performance of defensive stocks historically thrives in a slowing economy. If the rally broadens in such an environment, it will need participation from the defensive sectors. If the market pulls back, defense should be the best place to be.
So far this year, defensive stocks have been dogs. But this is just a snapshot in time. Sector performance tends to rotate. Things might look a whole lot different by the end of the year. In the meantime, many of these stocks are undervalued ahead of a likely period of relative outperformance.
Here are two great defensive stocks to consider picking up.
Brookfield Infrastructure Corporation (BIPC)
- Dividend Yield: 3.4%
Bermuda-based Brookfield Infrastructure Corporation owns and operates infrastructure assets all over the world. The company focuses on high-quality, long-life properties that generate stable cash flows, have low maintenance expenses and are virtual monopolies with high barriers to entry.
Infrastructure is defined as the basic physical structures and facilities needed for the operation of a society or enterprise. It includes things like roads, power supplies and water facilities. Not only are these some of the most defensive and reliable income-generating assets on the planet but infrastructure is rapidly becoming a popular subsector.
The world is in desperate need of updated infrastructure. The private sector is filling the need as governments don’t have all those trillions lying around. Limited partnerships, giant sovereign-wealth funds, multilateral and development-finance institutions are raising billions of dollars a year for infrastructure investments. It’s almost becoming a new asset class.
As one of the very few tested and tried hands, Brookfield is right there. It’s been successfully acquiring and managing these properties for more than a decade in a way that delivers for shareholders. Since its IPO in 2008, the original BIP has provided a total return of 848% (with dividends reinvested) compared to a return of 314% for the S&P 500 over the same period. And those returns came with considerably less risk and volatility than the overall market.
Brookfield operates a current portfolio of over 1,000 properties in more than 30 countries on five continents. The company operates four segments: Utilities (30%), Transport (30%), Midstream (30%) and Data (10%).
- Toll roads in South America
- Telecom towers in India and France
- Railroads in Australia and North America
- Utilities in Brazil
- Natural gas pipelines in North America
- Ports in Europe, Australia and North America
- Data centers on five continents
The dividend is rock solid with a low 70% payout ratio and a history of steady growth, The payout has grown by a CAGR (compound annual growth rate) of 10% per year since 2009 and the company is targeting 5% to 9% annual growth going forward.
BIPC is a good long-term investment anytime, as the above numbers illustrate, but it is particularly attractive now because it’s relatively cheap and can well navigate both inflation and recession.
The infrastructure company reported solid earnings in the first quarter with funds from operations (FFOs) per share growth of 12.5% over last year’s quarter. The company benefited from recent expansions and acquisitions but also showed solid organic growth. Meanwhile, the average S&P 500 stock has negative year-over-year growth for the first quarter.
Roughly 85% of revenues are hedged to inflation with automatic adjustments built into its long-term contracts and its crucial service assets are very recession resistant, and earnings should remain strong. It also helps that the stock pays a solid and growing dividend.
NextEra Energy, Inc. (NEE)
- Dividend Yield: 2.5%
Utility stocks fill a great niche in any investment portfolio, especially in an economy and market this uncertain. The sector is the most defensive on the market as earnings are virtually immune to economic cycles. Stocks also pay high dividends and typically hold up very well in down markets.
NextEra Energy provides all those advantages plus exposure to the fast-growing and highly sought-after alternative energy market.
NextEra Energy is the world’s largest utility. It’s a monster with over $20 billion in annual revenue and a $151 billion market capitalization.
Ordinarily, when you think of a huge utility you probably think it has lackluster growth and a stable dividend. But that’s not true in this case. Earnings growth and stock returns have well exceeded what is normally expected of a utility.
For the last 15-, 10-, and five-year periods, NEE has not only vastly outperformed the Utility Index. It has also blown away the returns of the overall market. How can that be?
It’s because it isn’t a regular utility. NEE is two companies in one. It owns Florida Power and Light Company, which is one of the very best regulated utilities in the country, accounting for about 55% of revenues. It also owns NextEra Energy Resources, the world’s largest generator of renewable energy from wind and solar and a world leader in battery storage. It accounts for about 45% of earnings and provides a higher level of growth.
Florida Power and Light is the largest regulated utility in the U.S. It has about 6 million customers in Florida. It is one of the very best electrical utilities in the country. There are a few good reasons why Florida is a great place to operate a utility.
The state has a growing population. Utilities have a limited geographical range, and a stagnant population can make it tough to grow. Plus, it is one of the most regulator-friendly areas in the country. That’s huge for getting approvals for periodic expansions and price hikes. It also doesn’t hurt that Floridians run their air conditioners like crazy, and just about all year long.
The alternative energy company, NextEra Energy Resources, is the world’s largest generator of renewable energy from wind and solar. Alternative energy is the future, and this company is at the top of the heap. The government and regulators love them for it. It’s also a huge benefit that the cost of clean energy generation constantly gets cheaper as technology advances.
There is also a huge runway for growth projects. NextEra deployed about $55 billion between 2019 and 2022 on growth expansions and acquisitions. The company is expecting an increase in investments of 1.5 times from year-end 2019 levels between 2021 and 2024.
A key aspect of this recommendation is timing. The stock is a decent bargain after a period of underperformance and ahead of a slowing economy, a period of historic market outperformance.
These two defensive stocks both look attractive in the new bull market.
Other Dividend Lists
The following lists contain many more high-quality dividend stocks:
- The Dividend Aristocrats List is comprised of 67 stocks in the S&P 500 Index with 25+ years of consecutive dividend increases.
- The High Yield Dividend Aristocrats List is comprised of the 20 Dividend Aristocrats with the highest current yields.
- The Dividend Achievers List is comprised of ~350 stocks with 10+ years of consecutive dividend increases.
- The Dividend Kings List is even more exclusive than the Dividend Aristocrats. It is comprised of 50 stocks with 50+ years of consecutive dividend increases.
- The High Yield Dividend Kings List is comprised of the 20 Dividend Kings with the highest current yields.
- The Blue Chip Stocks List: stocks that qualify as Dividend Achievers, Dividend Aristocrats, and/or Dividend Kings
- The High Dividend Stocks List: stocks that appeal to investors interested in the highest yields of 5% or more.
- The Monthly Dividend Stocks List: stocks that pay dividends every month, for 12 dividend payments per year.
- The Dividend Champions List: stocks that have increased their dividends for 25+ consecutive years.
Note: Not all Dividend Champions are Dividend Aristocrats because Dividend Aristocrats have additional requirements like being in The S&P 500.
- The Dividend Contenders List: 10-24 consecutive years of dividend increases.
- The Dividend Challengers List: 5-9 consecutive years of dividend increases.