- Uncertainty over the Federal Reserve’s rate plans and a slowing economy will continue to impact investor sentiment in 2023
- I remain bullish on companies with strong fundamentals, reasonable valuations, and growing dividend payouts amid the current market environment
- I recommend buying PepsiCo and 3M to hedge against further volatility in the new year
Fixed-income stocks have been in demand lately amid growing signs that the economic recovery is faltering due to the Federal Reserve’s ongoing plans to raise interest rates to combat persistently high inflation.
While non-profitable high-growth tech companies have fallen out of favor, defensive-minded value stocks with strong dividends and sound financials have outperformed the broader market by a wide margin amid the current backdrop.
Indeed, the ProShares S&P 500 Dividend Aristocrats ETF (NYSE:NOBL) - a measure of companies that have increased their dividends annually for the last 25 years or more - has fallen 4.5% over the past year, compared to the S&P’s 14.4% decline.
As such, I recommend buying shares of PepsiCo (NASDAQ:PEP) and 3M Company (NYSE:MMM), given their solid fundamentals, reasonable valuations, healthy balance sheets, and enormous cash piles. Perhaps of greater importance, both companies have long histories of dividend increases, making them attractive plays during this volatile time in the market.
PepsiCo
- *Year-To-Date Performance: -2.5%
- *Market Cap: $245.4 Billion
PepsiCo meets my strict criteria of profitable value companies that do well in challenging macroeconomic environments. The global food, snack, and beverage giant - best known for producing its namesake Pepsi Cola carbonated soft drink, as well as a wide variety of snacks, including corn, potato, and tortilla chips - has proven over time that it can withstand a slowing economy and still provide investors with increasing dividend returns.
In fact, PepsiCo has raised its annual dividend for 50 straight years, and shares currently yield 2.62%, which is soundly above the 1.59% implied yield for the S&P 500 index. With the dividend payout ratio above 60% for the current fiscal year, the consumer defensive company will likely announce its 51st consecutive yearly dividend increase in 2023.
Source: InvestingPro
Looking ahead, I believe Pepsi is well-placed to achieve ongoing growth amid the difficult operating backdrop as consumers divert more spending into basic needs. The well-diversified consumer products company operates in 200 countries and sells a wide range of items that people consume regardless of economic conditions.
PepsiCo currently has 23 brands in its portfolio that produce over $1 billion in annual sales, including notable soft drinks such as Pepsi, Mountain Dew, Gatorade, and Lipton Tea, as well as recognizable snack labels like Lay’s, Fritos, Doritos, Cheetos, and Quaker Foods.
As such, I expect the company to put in a solid performance in 2023, with shares likely to break out to new all-time highs, thanks to its strong track record of shareholder returns combined with its leading position in the food, snack, and beverage space.
PEP - which rose to a record peak of $186.84 on Dec. 13 - closed at $176.06 last night. At current levels, the Purchase, New York-based beverage-and-convenience food company has a market cap of $245.4 billion. Shares are down 2.5% so far in 2023 after scoring an annual gain of 4% in 2022.
The next major catalyst is expected to arrive next month when PepsiCo reports fourth-quarter financial results before the U.S. market opens on Feb. 9. Consensus calls for Q4 earnings per share of $1.65, improving 7.8% from the year-ago period, while revenue is expected to climb roughly 6% year-over-year to $26.7 billion. If confirmed, that would mark the highest quarterly sales total in its history, driven by fresh price increases for its sodas and snacks.
Source: Investing.com
Pepsi has either matched or topped Wall Street’s profit expectations in every quarter dating back to Q1 2012, while missing sales estimates only twice over the same period, demonstrating the strength and resilience of its underlying business.
3M
- *Year-To-Date Performance: +5.6%
- *Market Cap: $70 Billion
Despite facing several headwinds, such as mounting costs, rising geopolitical tension, and most recently, litigation over faulty ear plugs, 3M has certainly lived up to its billing as a top defensive stock for a market downturn due to its proven ability to generate strong free cash flow, allowing it to return more capital to shareholders over time.
Not only do shares of the industrial giant currently yield a market-beating 4.60%, but the company has raised its annual dividend for 52 years in a row, highlighting its exceptional track record when it comes to returning cash to investors.
Source: InvestingPro
In addition, 3M also boasts an extremely cheap valuation. With a forward price-to-earnings (P/E) ratio of 11, MMM stock comes at a substantial discount when compared to some of its notable competitors, such as Honeywell (NASDAQ:HON), Illinois Tool Works (NYSE:ITW), and Parker-Hannifin (NYSE:PH), which trade at 26.9 times, 26.4 times, and 32.3 times forward earnings, respectively.
Based on its valuation metrics, I reckon that 3M’s stock could be underrated by some investors who focus mostly on the company's near-term challenges. However, it’s important to remember that the materials conglomerate has a resilient business that has successfully weathered plenty of storms in the past.
MMM stock - which fell to a recent 52-week low close to $107 to reach its worst level since 2013 - ended Tuesday’s session at $126.60. Shares, which have bounced off their October lows along with the major stock indices, are up 5.6% through the first few trading weeks of 2023 after suffering an annual loss of 32.5% in 2022.
In my view, 3M will finally see shares bottom this year thanks to receding concern over the company’s long-term growth prospects as it starts to reap the benefits of its ongoing operational restructuring actions, portfolio adjustments, and cost-cutting measures.
Unsurprisingly, the average fair value for MMM stock on InvestingPro according to a number of valuation models - including P/E multiples - implies 28.1% upside from the current market value over the next 12 months to about $163/share.
3M is scheduled to deliver Q4 numbers on Tuesday, Jan. 24 before the opening bell. Consensus calls for EPS of $2.37 per share, rising 2.6% from the year-ago period, while revenue is expected to decline 6.2% year-over-year to $8.07 billion.
Source: Investing.com
All in all, 3M looks poised to rebound, barring any catastrophic legal outcomes. The diverse manufacturing company checks most of the marks on my list which helps me identify high-quality blue-chip companies with strong dividends and attractive valuations to add to my portfolio, regardless of what condition the economy is in.
Disclosure: At the time of writing, I am long on the S&P 500 and Nasdaq via the SPDR S&P 500 ETF (SPY) and Invesco QQQ ETF (QQQ). I am also long on the Technology Select Sector SPDR ETF (XLK). The views discussed in this article are solely the opinion of the author and should not be taken as investment advice.