When faced with market uncertainty, playing it safe and investing in quality is wise. So it makes sense to listen to an investing legend about stock quality. Quoting Peter Lynch, “This is one of the keys to successful investing: focus on the companies, not on the stocks.”

Below are 4 quality companies and dividend stocks to play defense in case of unexpected market behavior. Some dividend stocks tend to have lower volatility when the market faces uncertainty, providing peace of mind.

4 Dividend Stocks to Play Defense

McDonald’s

McDonald’s Corporation (MCD) is the largest quick-service restaurant chain in the world. Consumers know it as a place for fast, consistent food. The company owns or franchises 40,000+ restaurants globally. It sells burgers, chicken sandwiches and nuggets, french fries, sodas, shakes, coffee, etc., to billions annually. The firm is the market leader by far, with $23,183 million in revenue in 2022 and $23,415 million in the past twelve months. 

Despite periodic negative press about unhealthy meals, the firm continues to grow over time. Moreover, the firm has expanded in the face of relentless competition in a business with no barriers to entry. But McDonald’s future revenue growth will come from expanding locations, adding menu items, and price increases.

McDonald’s success has allowed it to return cash to shareholders. The stock is a Dividend Aristocrat with 48 years of increases. The forward dividend yield is 2.1%, with a 5-year growth rate of 8%. Moreover, the payout ratio is only 56%, giving confidence about the dividend safety and future growth. In addition, it receives a dividend quality grade of B+. 

The stock is not volatile, with a 5-year beta of 0.63. Additionally, consumers purchase the company’s food and drinks in good times and bad. McDonald’s is probably priced near fair value, but investors may want to track this stock for a good entry point.

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Source: Portfolio Insight*

California Water Service Group

Water is an essential service for consumers and businesses. Hence, water stocks are solid conservative investments because of their regulated nature and monopolies. A primary player in San Jose, California, is the California Water Service Group (CWT). Besides northern California, the firm operates in Hawaii, New Mexico, Washington, and Texas, giving the utility national scale.

Organic growth and bolt-on acquisitions have resulted in the continued growth of water and wastewater connections. The firm has roughly 496,400 customer connections in California, 6,200 in Hawaii, 37,500 in Washington, 10,700 in New Mexico, and 2,200 in Texas. California Water serves about two million people.

California Water is a Dividend King, one of three water utilities on the list. The dividend growth streak is 56 years. The 5-year dividend growth rate is around 6.8%. The forward yield is 1.88%, more than the past 5-year average. The utility also receives an A+ dividend safety score.

Water stocks tend to trade at a high price-to-earnings ratio, and California Water is no exception. The P/E ratio (FWD) is ~29X, but the value is below the 5-year and 10-year ranges. Furthermore, the beta value is low at 0.48. Hence, we view this stock as a buy now.

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Source: Portfolio Insight*

Colgate-Palmolive

A quintessential dividend stock to play defense is Colgate-Palmolive (CL), the producer of oral, personal care, home care, and pet nutrition products. The over 200-year-old firm is the global market leader in toothpaste, with a ~40% market share. Besides Colgate, the company’s other brands include Ajax, Palmolive, Tom’s of Maine, Speed Stick, Softsoap, Sanex, Filorga, etc. Total revenue reached $17,967 million in 2022 and $18,338 million in the past twelve months.

Growth drivers are brand extensions to increase market share and periodic tuck-in acquisitions. The firm acquired Filorga and Hello in 2019 and 2020. New brands benefit from Colgate’s marketing and distribution scale and cost efficiencies. The combination has allowed Colgate-Palmolive to attain high gross and operating margins.

Colgate-Palmolive is another Dividend King with 60 years of increases in a row. However, dividend growth has slowed to the low-single-digits because the firm operates in mature markets, and the payout ratio is near 62%. The forward dividend yield is 2.45% supported by a dividend quality grade of an ‘A.’

The stock usually trades at an elevated P/E ratio because of its consistent performance and defensive characteristics. Consumers need toothpaste and other items regardless of economic conditions. However, Colgate-Palmolive trades at a valuation near the bottom of its 5-year range, and the beta is only 0.49. Consequently, we view Colgate-Palmolive as a buy.

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Costco Wholesale

The last dividend stock on our list to play defense is Costco Wholesale (COST), the giant warehouse retailer. Costco is known for its enormous, no-frills warehouses selling large quantities of electronics, groceries, personal and household care products, clothing, gasoline, and more. Despite selling less items in fewer stores, the company’s business model has allowed it to reach $226,954 million in sales in 2022 and $234,390 million in the trailing twelve months.

Costco will probably add to the total sales by opening new stores in new geographic areas in the United States and internationally. The retailer makes its profits mainly on membership fees that are increased every few years. Customers obviously like Costco’s offerings and way of selling because renewal rates are 90%+.

In addition, Costco is a dividend growth stock with 19 years of increases, making it a Dividend Contender. The growth rate is typically between 10% and 13% per year. The firm has many more years of increases ahead of it because of the modest ~26% payout ratio. However, the dividend yield is low at only 0.83%.

Inflationary headwinds in 2022 and 2023 have pushed the stock price down from its all-time high. As a result, it is trading at a P/E ratio of ~34X, below its 5-year range, but still high. Nevertheless, with a beta of about 0.79 and an A+ dividend quality score, investors may want to buy this high-quality retailer.

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