While the stock market has been relatively strong over the past few weeks, there are many signs that the economy isn’t very strong. Last quarter’s GDP figures showed that the economy is stagnant, and we also saw that retail sales have been relatively weak in the past couple of months.
With these points in mind, it makes sense to include a couple of defensive stocks in your portfolio. But what constitutes a “defensive” stock? While there is no single answer to this question, there are several characteristics that you want to have in stocks that you own during a recession. First and foremost, the company needs to be able to generate strong free cash-flow even if economic activity is slowing down. This would eliminate most industrial companies, as well as many consumer discretionary stocks because business investment will decline and so will consumer spending. Stocks that should be able to generate strong free cash-flow include utilities and consumer staple names. These companies sell products that people need to buy even if they have less money to spend.
Companies that collect regular payments in exchange for products that people need or products that cost very little are good places to look. For instance, people aren’t going to cancel their phone service in a recession unless things are really bad. But they might cancel a magazine subscription or HBO.
Given these points, I think investors should consider the following stocks for their portfolios. They won’t rocket higher in an up market, but they will pay dividends and retain their value in the event of a market correction or in a recession.
1. Verizon (NYSE:VZ)
As I just mentioned, people will probably not cancel their phone service during a recession. Verizon is a company that is going to generate cash-flow in most economic scenarios because it provides an essential service. It also trades at a relatively cheap valuation at just 11 times earnings, and it pays a 4.5 percent dividend yield.
Recently, the stock has risen because some big name investors such as Dan Loeb and Warren Buffett have added the name to their portfolios. Thus, I think investors who are interested should wait for a pullback. Nevertheless, people who use Verizon’s phone or Internet services are going to continue to make regular payments to the company even if they make cuts elsewhere. Furthermore, many experts on the subject believe that Verizon has a superior service, and as a result, the company has had relatively strong subscriber growth when compared with its peers such as AT&T (NYSE:T). This gives the company another potential catalyst going forward.
2. Franco-Nevada (NYSE:FNV)
Gold is an asset you want to own in a weak economy, and the best way to do that as an investor looking for cash-flow and dividends is through a royalty or streaming company. These companies don’t actually mine gold. Rather, they make deals with mining companies who give the royalty companies gold on a regular basis in exchange for an upfront payment which is often used to develop the mine in question. Royalty companies have low, fixed costs, and so their margins will be very strong.
While there are a few royalty companies, Franco-Nevada is probably the best one to own if you are looking to get defensive. The company has no debt and $770 million in working capital. The stock should provide investors with leverage to the gold price. Gold is not only uncorrelated to the S&P 500, but it is undervalued. A rising gold price should generate interest in Franco-Nevada shares, and the company’s stable business model that focuses on cash-flow will also generate interest.
3. Consolidated Water (NASDAQ:CWCO)
While this is an article about defensive companies, I wanted to give investors an option that is a little riskier, but which still possesses the qualities that I highlight above. Consolidated Water is a small, $150 million market cap company that supplies fresh water throughout Latin America. It builds plans that desalinate water for consumption. The company recently reported a weak earnings figure due to unforeseen expenses at two of its plants. The stock tumbled, but I think this presents an opportunity. The company provides a necessary service for one of the most essential commodities known to man: water. Given water’s scarcity and the fact that most of the planet’s water cannot be consumed in its present form, Consolidated Water is going to be largely recession proof. It will also continue to generate free cash-flow in a weak economic environment, and it will pay a nearly 3 percent dividend if you buy at the current level.
As a micro-cap company investors should only buy a small amount of Consolidated Water, and if you choose to do so make sure you use limit orders when you buy, as you don’t want the volatility in this name to hurt you.
Disclosure: Ben Kramer-Miller has no positions in any of the stocks mentioned in this article.