While the economy seems to be performing well as we recover from the COVID-19 pandemic, there is always the possibility that the country hits another recession. The most likely catalyst for another recession would be a return of the pandemic that forces a fresh spate of lockdowns.
If another recession does come, here are three stocks that should outperform the market. Two are income stocks, and one is a growth stock.
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Realty Income (O -0.78%)
Realty Income is one of the few real estate investment trusts (REITs) that increased its earnings and hiked its dividend during the COVID-19 pandemic. Realty Income's business model is simply more resilient than those of most retail-driven REITs, in that it focuses on investment-grade (in other words highly stable) tenants that are in essential businesses -- think drug stores, shipping companies, and dollar stores.
If we are forced to shut down non-essential stores again, Realty Income will be less affected than most mall REITs, which generally concentrate on department stores and consumer discretionary retailers. Realty Income wasn't completely immune to COVID -- some of its tenants were impacted, particularly its theater and fitness clients. But Realty Income is also a Dividend Aristocrat, part of a group of elite companies that have hiked their dividends for at least 25 consecutive years.
Realty Income is trading at 21 times 2020 adjusted funds from operations (AFFO), which is at the high end of its historical range. The stock also has a dividend yield of 3.9%. Historically, Realty Income has traded with a dividend yield between 3.5% and 5%. The stock is trading on the rich side based on dividend yield -- but given the company's history of dividend increases, it might not stay rich for long. While Realty Income is generally thought of as an income stock, it also makes a good defensive stock.
Duke Energy (DUK 1.83%)
Duke Energy is a public utility, which means it has a highly recession-proof business model. Duke serves the Southeast and the Midwest, providing regulated electricity and natural gas services. Regulated utilities are generally given monopolies in exchange for accepting price controls. Each state has a public utility commission that's charged with representing the consumer (meaning the ratepayer). The state regulators essentially tell the company how much it is permitted to charge for its consumers.
The state regulators might drive a hard bargain, but they have an interest in ensuring that a utility covers its costs and provides adequate services. Since electricity demand is relatively insensitive to the economy, public utilities are often a go-to sector when it looks like the economy is weakening. Duke is trading at 20 times estimated 2021 earnings per share -- toward the lower end of its historical range of 15 to 30 times earnings -- and has a 3.9% dividend yield. Like Realty Income, Duke is a an income stock that makes a good defensive play as well.
American Tower (AMT 1.45%)
American Tower is a cellphone tower REIT that's benefiting from increasing demand for mobile data. The company's biggest customers are AT&T, T-Mobile, and Verizon, which account for 89% of its revenue combined. These companies lease space on American Tower's transmission towers. Like Realty Income, American Tower benefits from highly stable customers.
American Tower is insulated from the ebbs and flows of the economy because of consumers' voracious appetite for mobile data. On the company's first-quarter earnings conference call, it said that the average smartphone user consumes 15 gigabits per month, and it expects that number to grow to 50 gigabits per month by 2026, which works out to a 27% cumulative average growth rate.
While most investors consider American Tower a growth stock (which makes sense), it also rewards its shareholders with income. The company has hiked its dividend every quarter since April 2012. The company is guiding for 2021 AFFO per share to rise to $9.50 per share, which gives the stock a multiple of 31 times AFFO per share. Again, this is toward the high end of its historical range. The dividend yield is 1.8%, which is small for a REIT, but you are getting 12% annual AFFO per share growth, and a longer-term growth story. Historically, American Tower has traded with a dividend yield between 1.4% and 2.25%, so the stock is in the middle of its range.
American Tower and Realty Income are both trading on the high side of their historical valuation range. That's typical when the stock market's trading at record highs; every potential stock investment will seem expensive compared to historical multiples.
Keep in mind that these stocks have resilient business models that will perform well even in a recession. If the economy goes into a recession, expect their price-to-earnings ratios to fall, but the businesses themselves should hold up despite the economy. Investors can't really escape overall multiple compression without trying to time the market, which is generally a losing proposition..
Duke Energy and Realty Income are good income stocks that will hold up reasonably well if we get another outbreak of COVID or the economy weakens materially. Think of them as income stocks that double as defensives. American Tower is a growth stock, and revenues should continue to grow as the market for mobile data increases.
