In the current economic climate, it's clear that growth stocks have fallen out of favor. Instead, over the past year, defensive options have yielded market-beating returns. And while many top growth stocks have seen impressive year-to-date increases, most are still down considerably more than their defensive counterparts.
Thus, with the Federal Reserve still keeping its foot on the macroeconomic brakes (with at least one more rate hike likely), investors have reason to remain cautious with their capital allocation. Having at least a portion of one's portfolio invested in sturdy, cash flow-producing companies can lead to returns that, at the very least, align more closely with those of the overall market.
That said, growth stocks have vastly outperformed value stocks over the past decade and a half, and so it's prudent for equity investors to hold a mix of growth and defensive stocks.
With that in mind, I'm going to highlight two options for investors seeking a solid mix of both right now. These companies are both trading at levels I think are absurdly cheap, particularly compared to their averages during previous strong markets.
Devon Energy
Devon Energy (DVN -0.21%) is an energy giant that's focused primarily on the exploration and development of oil, natural gas, and liquefied natural gas. The company's oil and gas assets are in the Williston Basin, Anadarko Basin, Delaware Basin, Powder River Basin, and Eagle Ford.
Given the company's overall exposure to energy prices, Devon's stock price has been on a rocky ride in recent years. On a year-to-date basis, this stock is down approximately 12% at the time of writing, which is more than double the decline seen in various ETFs which track the oil sector. However, this stock has been one of the biggest winners in its sector as a result of oil prices that have normalized over the past three years, more than tripling since the start of 2021. Additionally, on a total return basis, Devon's sky-high dividend yield (more than 9% right now, including the variable component) has provided some welcome capital return to those who have held this stock for long periods.
Devon's variable dividend, which allows for 50% of the company's cash flows to be paid out to investors, complements the fixed dividend. Thus, when times are good, Devon pays out generously. When oil prices are lower, the company keeps the cash to bolster its balance sheet. That's the kind of flexibility long-term investors ought to like. Potential income investors must keep in mind that $0.23 of the company's $0.34 dividend this past quarter was variable, so this is a meaningful factor investors need to watch closely.
Despite a stock price that has nearly doubled since Q3 2021, Devon's price-to-earnings multiple has declined over this time at a relatively steady clip. This suggests to me that investors are less bullish about the company's future prospects and about the outlook for energy prices.
Which direction oil prices trend really depends on how the global supply and demand picture shakes out, so it's difficult for investors to pinpoint where earnings will be in the future. However, looking at Devon's debt levels (current debt/EBITDA ratio of 0.65-times, which is better than 73% of its peers), and its return on equity of nearly 60% (better than 90% of its peers), this current valuation multiple of less than 6-times trailing earnings certainly seems far too low.
I don't think investors can go wrong owning this long-term cash flow machine at such a rock-bottom multiple. Regardless of where oil prices go, shareholders are likely to be paid to be patient. For those with a long-term investing time horizon, this is the kind of stock I think is worth owning as an energy component in a diversified portfolio.
Meta Platforms
An underperformer in 2022, social media giant Meta Platforms (META 0.08%) has certainly rebounded nicely this year. Year to date, Meta stock is up more than 90% at the time of writing, so plenty of investors might think that this run is done. That sentiment is fair, since little has changed with Meta since the start of the year.
Yes, the company has done some serious cost cutting and has made 2023 the "year of efficiency," prompting many to suggest that Meta is turning its focus to its core business. In many respects, it is. However, Meta is still investing heavily on its bet that the metaverse is the future. The company's Reality Labs division continues to post multibillion-dollar losses per quarter. And the company still relies heavily on advertising revenues generated by Facebook and Instagram.
My view on Meta is that it's a highly profitable, cash flow-producing business that's offering investors some optionality. If the metaverse business pans out, even to a less grandiose extent than the company's management team is expecting, Meta will have a first-mover advantage in a potentially lucrative space.
But even if Meta's ambitions are completely out of line with reality, the metaverse doesn't pan out at all, and the Reality Labs division ultimately folds, the company can shoulder that loss. It can divert resources toward more productive endeavors, and investors will buy into the story that this is a streamlined, focused tech giant once again.
I think this period of short-term pain will ultimately be just that -- short. Over the longer term, Meta's ability to generate cash flow growth with its core social media franchises is really what investors should pay attention to. In this regard, I think Meta's valuation of roughly 25 times trailing earnings is very attractive.
These hot stocks could rise even more
A dividend-paying energy company and a social media giant couldn't be more different, so investors buy into these hot stocks for completely different reasons. However, a combination of income and growth is what I think makes a portfolio great -- and lowers volatility when one of those factors is out of favor.
If this risk-on rally persists and tech stocks continue to soar, investors holding both stocks will get the benefit of holding Meta. Should inflation pick back up, recession fears take hold, or investors choose to flee to safety, Devon is likely to attract more attention. In either case, investors win.
While I hold Meta stock right now, I don't own any Devon, and I am considering buying on any additional downward pressure from here. They're both extremely cheap stocks, though I don't think either is a value trap (stocks that look cheap, but aren't relative to their future prospects) at these levels right now.