There's a lot of uncertainty as we enter 2023. Many investors believe higher interest rates to combat inflation will cause a significant economic slowdown in the new year. Recessions tend to cause economically sensitive companies to report much lower earnings, often forcing them to slash cash outflows, including dividend payments.
But some companies are in a better position to weather an economic storm than others because their businesses generate much less-volatile earnings and free cash flow (FCF). So their dividends should withstand a recession.
Two companies with some of the lowest earnings volatility in the S&P 500 are Valero Energy (VLO -0.32%) and Realty Income (O 0.52%). That makes them among the best dividend stocks to buy for those worried about a recession in the upcoming year.
1. A resilient refiner
Valero has some of the lowest volatility in earnings and FCF in the energy industry, a sector known for its volatility. As the following slide indicates, Valero's earnings and FCF volatility are at the bottom of the barrel compared to its refining sector peers:
Image source: Valero Energy.
This slide also notes that Valero has historically traded at a much higher FCF yield than other companies in the energy sector at around 8%, even though it has much lower FCF volatility. That makes it a relatively more-attractive investment opportunity since it should produce less-volatile cash flows in 2023 than other energy stocks and companies in more cyclical industries like materials, consumer discretionary, and real estate.
Another factor that should insulate Valero from a recession in 2023 is its embedded growth. The company invested $2 billion this year on projects that should start paying dividends in 2023. It brought its Diamond Green Diesel 3 project on line at the end of 2022 and expects to finish its Port Arthur coker project in 2023.
These and other capital projects should add $1.2 billion to $1.7 billion of annual earnings by the end of next year. That positions Valero to grow its stable earnings by more than 50% from its average over the last few years.
The market isn't giving Valero any credit for this growth, which is why it trades at a higher dividend yield of 3.1%, almost double the S&P 500's 1.7% dividend yield. The company's combination of growth, income, and value makes it look like a great investment opportunity.
2. A reliable real estate stock
While real estate companies tend to be more cyclical and have greater earnings volatility, Realty Income falls at the other end of the spectrum. The real estate investment trust (REIT) has some of the lowest earnings and dividend volatility of stocks in the S&P 500:
Image source: Realty Income Investor Relations Presentation.
The REIT has grown its adjusted funds from operations (FFO) per share in 25 of its 26 years as a public company. The only down year came in 2009 during the financial crisis when it saw a modest decline. Overall, Realty Income's adjusted FFO has expanded at a 5.1% compound annual rate.
Meanwhile, the REIT has an impressive streak of increasing its dividend. It has given its investors 118 raises since its initial public offering in 1994, including for 101 straight quarters. Realty Income's dividend currently yields 4.7%.
A big driver of Realty Income's earnings and dividend stability is its rock-solid portfolio. The company gets 92% of its rent from businesses resilient to economic downturns or those isolated from the pressures of e-commerce.
And it uses triple net leases, making tenants responsible for insurance, maintenance, and real estate taxes. Because of that, it collects very steady rental income to pay dividends. It also has a strong financial profile, allowing it to continually acquire income-producing properties to grow the dividend.
Rest easy in the new year with these rock-solid dividend stocks
A recession could impact the earnings of economically sensitive companies, potentially causing them to reduce or eliminate their dividends in 2023. But that's not a concern for investors in Valero Energy and Realty Income since they have some of the lowest earnings and FCF volatility in the S&P 500.
Because of that, they should have no problem maintaining their payouts in the new year, making them stand out among the best dividend stocks to buy for stability.
