Protect Your Portfolio With Defensive Stocks
This week, we use AAII’s A+ Investor Stock Grades to provide insight into three defensive stocks. With widespread economic uncertainty, should you consider the stocks of Colgate-Palmolive Co. (CL), Kimberly Clark Corp. (KMB) and Procter & Gamble Co. (PG)?
Defensive Stocks Recent News
The investing landscape in 2022 was notable not only for the severity of losses but also their breadth: It was the first year, since at least the 1870s, that U.S. stocks and long-term bonds both fell by more than 10%. As a result, investors have turned to defensive stocks.
Defensive stocks are companies that generally hold up well in times of economic distress. The main defensive sectors are generally considered to be utilities, health care and consumer staples, all of which have outperformed the market in 2022. Even in a downturn, consumers continue to spend money on these products.
As of December 29, the S&P 500 index’s utility stocks as a whole fell 0.5% in 2022, while consumer staples were down 2.7% in the period. This may seem poor, but the broader market fell roughly 20% during the year. Despite the better performance, cyclical sectors such as industrials and consumer discretionary have outpaced defensive stocks on earnings growth. Fourth-quarter earnings for Colgate, Kimberly Clark and Procter & Gamble have largely been in line with expectations.
Overall, defensive stocks are favored by investors during tough economic times as companies operating in the space feel little impact of the broader economic downturn. As long as the Federal Reserve continues raising interest rates, the economy will continue to slow. Investors will likely still turn to defensive stocks to protect their portfolios.
Grading Defensive Stocks With AAII’s A+ Stock Grades
When analyzing a company, it is helpful to have an objective framework that allows you to compare companies in the same way. This is why AAII created the A+ Stock Grades, which evaluate companies across five factors that have been indicated by research and real-world investment results to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.
Using AAII’s A+ Stock Grades, the following table summarizes the attractiveness of three defensive stocks — Colgate, Kimberly Clark and Procter & Gamble — based on their fundamentals.
AAII’s A+ Stock Grade Summary for Three Defensive Stocks
What the A+ Stock Grades Reveal
Colgate-Palmolive Co. (CL) is a household and consumer products company. The company operates in two product segments: oral, personal and home Care; and pet nutrition. The oral, personal and home care segment is managed geographically through five segments — North America, Latin America, Europe, Asia Pacific and Africa/Eurasia — all of which sell primarily to a variety of traditional and e-commerce retailers, wholesalers, distributors, dentists and skin health professionals. Through Hill’s Pet Nutrition, the company is also engaged in the pet nutrition market, selling products principally through authorized pet supply retailers, veterinarians and e-commerce retailers. It also sells some of its products direct-to-consumer. It sells its toothpastes under brands such as Colgate, Darlie, elmex, hello, meridol, Sorriso and Tom’s of Maine; its toothbrushes under brands, such as Colgate, Darlie, elmex and meridol; and its mouthwashes under brands, such as Colgate, elmex and meridol.
A higher-quality stock possesses traits associated with upside potential and reduced downside risk. Backtesting of the Quality Grade shows that stocks with higher grades, on average, outperformed stocks with lower grades over the period from 1998 through 2019.
Colgate has a Quality Grade of A with a score of 98. The A+ Quality Grade is the percentile rank of the average of the percentile ranks of return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals to assets, Z double prime bankruptcy risk (Z) score and F-Score. The F-Score is a number between zero and nine that assesses the strength of a company’s financial position. It considers the profitability, leverage, liquidity and operating efficiency of a company. The score is variable, meaning it can consider all eight measures or, should any of the eight measures not be valid, the valid remaining measures. To be assigned a Quality Score, though, stocks must have a valid (non-null) measure and corresponding ranking for at least four of the eight quality measures.
The company ranks strongly in terms of its return on assets, F-Score and gross income to assets. Colgate has a return on assets of 12.4%, an F-Score of 7 and a gross income to assets of 62.9%. The sector median return on assets and F-Score are 1.8% and 4, respectively. Colgate ranks above average for every quality metric except change in total liabilities to assets.
Earnings estimate revisions offer an indication of how analysts view the short-term prospects of a firm. For example, Colgate has an Earnings Estimate Revisions Grade of D, which is negative. The grade is based on the statistical significance of its latest two quarterly earnings surprises and the percentage change in its consensus estimate for the current fiscal year over the past month and past three months.
Colgate reported an earnings surprise for fourth-quarter 2022 of 0.8%, and in the prior quarter reported an earnings surprise of 1.1%. Over the last month, the consensus earnings estimate for the first quarter of 2023 has decreased from $0.745 to $0.713 per share due to two upward and 11 downward revisions. Over the last three months, the consensus earnings estimate for full-year 2023 has decreased 1.4% from $3.166 to $3.122 per share due to five upward and 13 downward revisions.
The company has a Value Grade of F, based on its Value Score of 17, which is considered ultra expensive. This is derived from a high price-to-book-value (P/B) ratio of 97.92 and a price-to-free-cash-flow (P/FCF) ratio of 89.9, which rank in the 99th and 89th percentiles, respectively. Colgate has a Growth Grade of A based on a score of 89. The company has had strong sales increases over the last five years.
Kimberly Clark Corp. (KMB) is engaged in the manufacturing and marketing of a range of products made from natural or synthetic fibers using technologies in fibers, nonwovens and absorbency. The company’s segments include personal care, which offers solutions and products such as disposable diapers, training and youth pants, swim pants, baby wipes, feminine and incontinence care products and other related products sold under the Huggies, Pull-Ups, Little Swimmers, GoodNites, DryNites, Sweety, Kotex, U by Kotex, Intimus, Depend, Plenitud, Softex, Poise and other brand names. The consumer tissue segment offers facial and bathroom tissue, paper towels, napkins and related products sold under the Kleenex, Scott, Cottonelle, Viva, Andrex, Scottex, Neve and other brand names. The K-C Professional segment offers solutions and supporting products such as wipers, tissue, towels, apparel, soaps and sanitizers. Its brands include Kleenex, Scott, WypAll, Kimtech and KleenGuard.
The company has a Value Grade of D, based on its Value Score of 22, which is considered to be expensive. Higher scores indicate a more attractive stock for value investors and, thus, a better grade.
Kimberly Clark’s Value Score ranking is based on several traditional valuation metrics. The company has a rank of 22 for shareholder yield, 99 for the price-to-book ratio and 95 for the price-to-free-cash-flow ratio (with the higher ranks being better for value). The company has a shareholder yield of 3.4%, a price-to-book ratio of 99.65 and a price-to-free-cash-flow ratio of 164.5. The company has a price-to-sales ratio of 2.16, which translates to a rank of 52.
The Value Grade is based on the percentile rank of the average of the percentile ranks of the valuation metrics mentioned above, along with the ratio of enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA), price-to-sales (P/S) ratio and price-earnings (P/E) ratio. The rank is scaled to assign higher scores to stocks with the most attractive valuations and lower scores to stocks with the least attractive valuations.
Kimberly Clark has a Momentum Grade of C, based on its Momentum Score of 50. This means that it is average in terms of its weighted relative strength over the last four quarters. This score is derived from an above-average relative price strength of –2.8% in the most recent quarter, –0.3% in the second-most-recent quarter, –1.7% in the third-most-recent quarter and 3.5% in the fourth-most-recent quarter. The scores are 54, 48, 53 and 66 sequentially from the most recent quarter. The weighted four-quarter relative price strength is –0.8%, which translates to a score of 50. The weighted four-quarter relative strength rank is the relative price change for each of the past four quarters, with the most recent quarterly price change given a weight of 40% and each of the three previous quarters given a weighting of 20%.
Kimberly Clark has a Quality Grade of A with a score of 90. The company ranks strongly in terms of its return on assets, F-Score and gross income to assets. Kimberly Clark has a return on assets of 9.9%, an F-Score of 7 and a gross income to assets of 34.9%.
Procter & Gamble Co. (PG) is focused on providing branded consumer packaged goods to consumers across the world. The company operates through five segments: beauty; grooming; health care; fabric and home care; and baby, feminine and family care. The company sells its products through approximately 180 countries and territories primarily through mass merchandisers, grocery stores, membership club stores, drug stores, department stores, distributors, wholesalers, baby stores, specialty beauty stores, e-commerce, high-frequency stores, pharmacies, electronics stores and professional channels. It offers products under the brands Head & Shoulders, Herbal Essences, Pantene, Rejoice, Olay, Old Spice, Safeguard, Secret, SK-II, Braun, Gillette, Venus, Crest, Oral-B, Metamucil, Neurobion, Pepto-Bismol, Vicks, Ariel, Downy, Gain, Tide, Cascade, Dawn, Fairy, Febreze, Mr. Clean, Swiffer, Luvs, Pampers, Always, Always Discreet, Tampax, Bounty, Charmin and Puffs.
Procter & Gamble has a Quality Grade of A with a score of 97. The company ranks strongly in terms of its return on assets, F-Score and buyback yield. Procter & Gamble has a return on assets of 11.9%, an F-Score of 7 and a buyback yield of 2.0%.
Procter & Gamble has a Momentum Grade of C, based on its Momentum Score of 45. This means that it is average in terms of its weighted relative strength over the last four quarters. The weighted four-quarter relative price strength is –1.7%.
Procter & Gamble reported a positive 0.1% earnings surprise for fourth-quarter 2022, and in the prior quarter reported an earnings surprise of 1.8%. Over the last month, the consensus earnings estimate for the first quarter of 2023 has decreased from $1.352 to $1.334 per share due to four upward and 13 downward revisions. Over the last month, the consensus earnings estimate for full-year 2023 has increased from $5.814 to $5.841 per share, based on 16 upward and two downward revisions.
The company has a Value Grade of F, based on its Value Score of 19. This is derived from a price-earnings ratio of 24.8 and a shareholder yield of 4.6%, which rank in the 67th and 17th percentiles, respectively. Procter & Gamble has a Growth Grade of A based on a score of 89. The company has had strong sales increases over the last five years.
The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.
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