With a bull market that is now well over 10 years old, and with a global economy that is facing slower growth ahead, many investors are wondering how they should be positioned. Bond yields offer 2% or less on most Treasury securities, and that pesky U.S. and China trade war is keeping growth lower while there are very few areas of the economy still growing as fast as in prior years. Investors use many strategies, and those who need or want to keep equity exposure often seek refuge in the solid dividend-paying defensive stocks that won’t fall apart in the next stock market pullback or if a recession finally hits.
Defensive stocks like utilities, consumer products and telecom are currently viewed as some of the go-to hotspots for investors in this category. These stocks generally are perceived to still offer long-term upside appreciation, dividend yields that compete with or exceed long-term Treasury yields, and shares that are unlikely to crater. All this is possible due to the low volatility of their underlying businesses. It’s the so-called Steady Eddie investment theme.
Many of the top defensive stocks have performed incredibly well during the bull market, and many of these stocks actually rally on days when the broader market indexes fall 1%, 2% or more. The problem heading into late 2019 and 2020 is that many of these Steady Eddie defensive stocks are now trading at serious premiums to the market that cannot be ignored. Yardeni Research has shown that the S&P 500 Index is now valued at 16.3 times its forward 12-month earnings per share projections, and many of these defensive stocks that used to be valued under the S&P’s multiple are now valued at 22, 25 and even over 30 times forward earnings.
The defensive stocks are supposed to offer a refuge, but if the investing community ever decides to make a big exodus or lock in long-term gains and call it a day, then there might be worse losses than investors would expect. With the media endlessly and prematurely calling for a recession, it could be a bad time even for defensive stocks if the economy goes from slowing to contracting sooner than expected.
24/7 Wall St. has used the midpoint of the forward earnings per share consensus estimate from Refinitiv for 2019 and 2020 for a blended forward earnings estimate. That is the “times earnings,” or a forward price-to-earnings (P/E) ratio in this case. We have evaluated dividend yields, market caps and trading history on each company, and we have offered additional color on what makes each of these defensive stock valuations so much higher than in the past.
We have referred to data in the past five years as a reference, but in some cases we have gone back almost 10 years to the “stocks to own for the decade” to illustrate just how much of a premium defensive stock investors are having to pay versus back then. Here are 15 defensive stocks that most investors would agree will see their businesses hold up relatively well, even if a recession lands sooner than expected, but these are also trading at nosebleed valuations that could bring pain investors may not have factored in.
American Electric Power
> Times Earnings: 21.5
> Dividend Yield: 3.0%
> Market Cap: $44.8 billion
American Electric Power Co. Inc. (NYSE: AEP) has been a stock to own for the decade for years now. Yet, at a time when interest rates have remained low, its stock has soared, its dividend has gone lower despite multiple dividend hikes and investors are paying nearly twice as much on a P/E ratio as they did before the demand for utility stocks went through the roof. AEP is a great utility looking to keep lowering its coal exposure, and investors keep paying up for it.
> Times Earnings: 56.0
> Dividend Yield: 1.5%
> Market Cap: $100.4 billion
American Tower Corp. (NYSE: AMT) had been a great growth stock, but it has converted to a real estate investment trust (REIT) for tax purposes. The company has no real exposure to China, and its business should hold up in the years ahead whether or not regulators allow wireless carrier consolidation. That said, it is valued exponentially higher than the top carriers are, and its dividend is a fraction of their payouts.
American Water Works
> Times Earnings: 33.0
> Dividend Yield: 1.6%
> Market Cap: $22.3 billion
American Water Works Co. Inc. (NYSE: AWK) is by far the best and largest water utility in America. It is diversified in many states and has millions of water utility customers, and investors seem to buy up its stock any day the market sells off. It remains a stock for the decade, but investors are now forced to pay more than twice the earnings multiple than in the past, and its dividend yield is half of what it used to be despite multiple dividend hikes.