The Nasdaq 100 index tracks the performance of the some of the largest nonfinancial companies in the U.S. This select group delivered a return of 360% over the last 10 years, almost double the return of the S&P 500, but worries over higher interest rates and skyrocketing inflation pulled the index down 29% year to date.
The Nasdaq 100 includes a top video-game producer and a grocery store staple that are outperforming the market year to date and could be great defensive stocks to buy ahead of 2023. They offer reasonable value, dividends, and very profitable underlying businesses with recurring revenue streams.
Outperform the market with video games
The video game industry is estimated to be worth around $200 billion, making it the largest entertainment market -- much bigger than movies and music. Electronic Arts (EA -0.65%) is the company behind several top gaming franchises, including Madden, FIFA, The Sims, and Apex Legends.
The year-round time that players spend on these games provides EA some stability during rough stretches in the economy. Many popular games are available free, where game companies monetize players with extra content that gamers purchase while playing.
EA is positioned to finish the current year in great shape. The immediate catalyst is the holiday shopping season, when EA has the latest releases from FIFA and Madden to drive strong sales. Management expects full-year revenue to be up between 9% and 12% year over year.
The ability to keep revenue growing in a year of high inflation explains why EA shares have outperformed this year. The stock is down only 6%, well ahead of the Nasdaq 100 and the S&P 500.
EA has grown its audience to 600 million players as of the most recent quarter. That's a massive audience for buying more games and extra content while playing. Over the last four quarters, in-game spending grew 20% year over year and contributed nearly three quarters of the company's bookings.
To sweeten the pot, EA pays out 11% of its free cash flow in dividends to shareholders, bringing the current yield to 0.58%. It's relatively low because management has abundant opportunities to reinvest most profits into new games and acquisitions to drive growth.
EA still trades at a market-average valuation of about 17 times expected earnings right now, which should lead to long-term returns that track the underlying growth of the business.
The market is undervaluing Kraft's improving growth
For investors looking for a defensive stock with an above-average dividend yield, look no further than Kraft Heinz (KHC -0.99%). The company has passed along higher costs to the consumer, which has kept sales growing this year and also explains why the stock is outperforming, only down 5% compared to the S&P 500's decline of 23%.
Since taking over the reins in 2018, CEO Miguel Patricio orchestrated a spectacular turnaround for the once-struggling food giant. With organic sales up 10% year over year in the last quarter, Kraft is now shifting its strategy to accelerate profit growth. It plans to use personalized marketing and innovation in its top food brands to achieve long-term annualized growth in adjusted earnings of 6% to 8% per year.
Profit growth spells a stream of increasing dividend payments to boost shareholder returns. Kraft Heinz paid out 61% of its free cash flow to shareholders over the last year. That brings the dividend yield to a tasty 4.84% at the current quote of $33.
With the stock trading at 12.4 times expected earnings this year, investors are getting a much better deal than the average stock, which trades above 15 times earnings. Kraft's pricing power, brand strength, and dividend yield are deeply undervalued by the market right now.