Benjamin Graham, who is widely known as "the father of value investing," argued that defensive stocks should be moderately priced, have a good record of paying dividends and be conservatively financed.
This is what long-term value investors are looking for now. Given the volatility in the equities market and uncertainty around the economy and interest rates, investors are looking for stocks with defensive qualities.
This means finding the best stocks to buy that will preserve investors' capital over the long term. Moreover, the top defensive stocks have the ability to grow their dividends.
Typically, these defensive companies generate a sufficient amount of free cash flow (FCF) that can support both dividend payments and also stock buybacks. FCF is the amount of cash flow that exceeds all the company's cash expenses (not including depreciation and amortization, for example). In addition, FCF covers the company's capital expenditure needs like new plant and equipment purchases, as well as working capital spending. What's left is "free" to be spent on dividends, buybacks, debt reduction, acquisitions of companies and cash accumulation.
It's often the case that these companies are boring. But they are profitable and can keep growing even when economic conditions are rough. In any event, they have a long history of generating good profit margins and cash flow during a variety of economic cycles. In addition, their price-to-earnings ratios are moderate and they have good dividend yields. These qualities make them good defensive plays for the long term.
With that in mind, here are the six best defensive stocks to buy now.
Data is as of January 16. Dividend yields are calculated by annualizing the most recent payout and dividing by the share price.
Wendy's
- Market value: $3.9 billion
- Dividend yield: 5.3%
Wendy's (WEN, $19.03) is the second largest hamburger quick service restaurant (QSR) chain in the U.S. and the third largest globally. It has more than 7,000 restaurants globally, the majority of which are in the U.S. Most of these are franchise-owned QSRs – roughly 93% of the stores in the U.S. are owned by 217 franchisees, and about 99% of the international QSRs are owned by 106 franchisees.
People love the Wendy's menu. Its earnings, cash flow and dividends are growing, and the company forecasts meaningful growth next year, as well. For example, global same-store sales were up 4.9% in 2022, thanks in part to 12.4% international growth. In addition, total sales grew 6.4% to $13.3 billion in 2022 over 2021.
Additionally, the company's adjusted earnings before interest, taxes, depreciation and amortization (EBITDA), a cash flow measure, grew 6.6% in 2022. Although its reported earnings per share (EPS) fell to 82 cents from 89 cents, Wendy's management now forecasts that in 2023 EPS will rise to between 95 cents and $1.00.
Moreover, its FCF is expected to rise to $270 million at the midpoint of guidance. This is more than enough to cover Wendy's $1.00 per share annual dividend, which only costs the company $206.3 million. WEN currently has 206.3 million shares outstanding, and this is expected to decrease as it buys back more of its shares. For example, the company repurchased 3.5 million shares last year for $51 million, and this year, it's on track to do the same.
That means that its 5.3% dividend yield looks secure. If that's not enough, investors seeking out the best defensive stocks can rest easy knowing the company has paid dividends for the past 19 years. And with WEN stock trading at 17.3 times forward earnings – below its five-year average – it is one of the best cheap stocks to boot.
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Pfizer
- Market value: $159.9 billion
- Dividend yield: 5.9%
Pfizer (PFE, $28.32) is a diversified pharmaceutical company that offers medicines and vaccines in a broad spectrum of therapeutic areas. Pfizer has a sturdy foundation of diverse drugs that produce strong cash flows for its shareholders.
Moreover, its huge size – $100.3 billion in revenue in 2022, including 13% year-over-year growth in Q4 alone – allows it to spend large amounts on R&D and capital expenditures. This gives PFE the kind of economies of scale that drug development requires.
For example, in its fiscal year ended December 31, 2022, Pfizer generated $26 billion in free cash flow, after all capex spending and working capital needs. That more than covered the company's $9 billion in dividends and $2 billion in share buybacks.
However, going forward, Pfizer projects lower revenue, as the COVID-19 vaccine revenue windfall eases back in 2023. Nevertheless, it still projects non-COVID revenue will be up 6% to 8% in 2023. This should still produce enough cash flow to cover its annual dividend of $1.68 per share and keep its 5.9% dividend yield very secure. This is especially the case as Pfizer had paid a dividend for the past 34 years, including 13 consecutive years of dividend growth.
In addition, the healthcare stock is inexpensive at just 12.6 times forward earnings. Combined with its strong free cash flow and its high dividend yield, investors should consider PFE as one of the best defensive stocks going forward.
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Microsoft
- Market value: $2.90 trillion
- Dividend yield: 0.8%
Microsoft (MSFT, $390.27) is a major software company with tentacles in every area of the industry: operating systems, cloud, gaming, artificial intelligence (AI) and application software.
MSFT has been around since 1975. More importantly, it has paid a dividend for the last 20 years, including 18 consecutive years of dividend growth. Its powerful free cash flow is more than sufficient to cover dividends, share repurchases, acquisitions and debt reduction.
For example, Microsoft pays a $3.00 per-share annual dividend, up 10.3% over last year, and it's likely to rise a similar amount this year. That gives MSFT an 0.8% dividend yield, not bad for a tech stock. And over the last 12 months ended June 30, 2023, Microsoft generated roughly $60 billion in free cash flow. That more than covered the $19 billion dividend cost, as well as $22 billion in share buybacks for the fiscal year.
This is because Microsoft's Office, LinkedIn and cloud services products (Productivity and Business Processes division) enjoy strong appeal with consumers (up 13% in the latest quarter). In addition, its other revenue in Intelligent Cloud grew 19% last quarter. The bottom line is that Microsoft's products are still relevant and the company is growing nicely.
It also spent $9.1 billion on buybacks last quarter, an $18.4 annualized rate. That tends to increase both its earnings and dividends per share going forward.
Given its healthy dividend yield and strong buyback program, investors might expect that the Dow Jones stock will do reasonably well over the next year.
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Coca-Cola
- Market value: $259.4 billion
- Dividend yield: 3.1%
Coca-Cola (KO, $59.99) is a well-known beverage company that has long produced consistently growing earnings, cash flow and dividends. Moreover, Coca-Cola has been buying back shares over and above the amount it issues to employees. This also helps increase its earnings and dividends on a per share basis.
In 2022, Coca-Cola's sales were up 11% to $43 billion, and on a non-GAAP "organic" basis, they grew 16%. This was composed of an 11% rise in prices, as well as a 5% increase in concentrate volume.
Moreover, KO's free cash flow was healthy at $9.5 billion. Although that was down from the prior year, it still represents a very respectable 22.7% of total sales. In other words, almost 23% of all Coca-Cola's sales goes straight to the company's net cash pile, before it spends money on dividends, buybacks and debt reduction.
In addition, Coca-Cola says it is gaining market share in the nonalcoholic ready-to-drink ("NARTD") beverages segments.
As a result, investors can continue to expect that Coca-Cola will keep raising its dividend as it has for the past 61 years straight. That is quite an achievement, and is likely one reason why KO is one of Warren Buffett's favorite stocks and a long-time member of the Berkshire Hathaway equity portfolio. The famed value investor and CEO of Berkshire Hathaway (BRK.B) has held shares in the company for 35 years, since 1988. Berkshire's stake in KO stock is now up to 9.25%, according to Coca-Cola's latest proxy.
Given that KO is at just 21 times forward earnings, slightly below its five-year average, it looks moderately priced, given its growth. Along with its 3.1% yield, KO is one of the best defensive stocks to buy.
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Oracle
- Market value: $292.9 billion
- Dividend yield: 1.5%
Oracle (ORCL, $106.57) is a major cloud software and services company that offers enterprise resource planning and enterprise performance management products.
In its most recently reported quarter, the company said revenue was up 5% year-over-year in U.S. dollars, and up 4% in constant currency, to $12.9 billion. Moreover, the company is extremely profitable and pays a hefty dividend – especially for a tech stock – along with share buybacks.
For example, Oracle's non-GAAP operating margins for the quarter were an impressive 43%. This puts it in the upper tier of profitable software companies. In addition, Oracle generated $10.1 billion in free cash flow during the last 12 months (LTM). That represents a healthy 20% of its LTM revenues. This FCF allows Oracle to pay a decent dividend and buy back its shares.
For example, the software company just hiked its dividend by 25% to $1.60 per share annually, giving ORCL stock a 1.5% dividend. This is the eighth year in a row ORCL has raised its dividend, showing that it is likely to be hiked again next year. Moreover, Oracle has bought back a significant amount of its shares in the past two years, although this year it has scaled back.
At just 19 times forward earnings, the stock looks to be moderately priced. For example, the forward P/E for the S&P 500 is at a slightly higher 22.1.
Given solid revenue growth, operating margins, free cash flow, dividends and buybacks, Oracle stock looks like one of the best defensive stocks to buy right now.
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Exxon Mobil
- Market value: $391.4 billion
- Dividend yield: 3.9%
Exxon Mobil (XOM, $97.69) is one of the biggest oil and gas companies in the world, with fiscal 2022 revenue of over $400 billion ($413.7 billion), up almost 45% from 2021 ($285.6 billion). This company has a long history, a solid brand, and is essentially a cash cow. Moreover drivers are going to need oil and gas products for a good while, despite the move to electric vehicles.
More importantly, cash flow went through the roof. The company generated $62.1 billion in free cash flow after all its capex spending.
As for fiscal 2023, analysts expect to see lower revenue at $345.8 billion, which isn't too surprising given how far oil prices fell in the fourth quarter. Nevertheless, the company is still likely to produce a significant amount of free cash flow going forward. For example, even if FCF fell by 20% over the fiscal year, it still means Exxon produced at least $50 billion in FCF over the 12-month period.
That will be more than enough to cover the $3.80 per share annual dividend. This costs Exxon $15.2 billion annually, given that it has 4.01 billion shares outstanding. Moreover, XOM's management said that following the closing of its purchase of Pioneer Natural Resources (PXD) in 2023, it plans on buying back $20 billion in stock each year through 2025. This will drop the share count and improve earnings and dividends per share over the next several years.
What's more, XOM is one of the best value stocks at the moment, trading at just 10.4 times forward earnings. Moreover, Exxon has grown its dividend every year over the past 41 years, and its 3.9% dividend yield is more than covered by expected cash flow going forward. These points make XOM stock one of the best defensive stocks for investors right now.
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