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What are we looking for?

Defensive U.S.-listed stocks providing a stable income stream, with a history of low earnings volatility and trading at attractive valuations.

The screen

Last year was one characterized by volatility: the S&P 500 saw a 52-week spread of 478 points; early-year leading sectors (telecom, utilities and consumer staples) were victims of sector shifts that accelerated following Donald Trump's electoral victory, while OPEC's supply-cut deal and higher inflation expectations catapulted the energy and financials sectors to the top of the pack by year end. We saw crude oil sink almost 30 per cent before ending the year 35 per cent higher than it was on Jan. 1, 2016. Gold rallied 30 per cent early on, yet crossed the finish line only 8 per cent higher than the start of last year. Ten-year U.S. Treasury yields dropped to a low of 1.32 per cent at the end of the second quarter, followed by a reversal in momentum to close at 2.43 per cent by year's end.

Looking at the year ahead, this rotation out of Treasuries and defensive sectors into more cyclical ones could be here to stay. Yet it would be wise to consider an alternative scenario in which volatility extends into 2017 and the heightened corporate earnings, inflation growth and rate-hike expectations don't materialize – leading to a reversal of this sector rotation. We screen for dividend yielding bond proxies capable of providing predictable income streams that aren't as sensitive to business cycle fluctuations:

  • Sectors: consumer staples, health care, telecom, and utilities;
  • Trailing price-to-earnings ratio of less than 21, and forward price-to-earnings ratio of less than 17;
  • Free-cash-flow yield greater than the dividend yield (that is, operating cash flows after accounting for capital expenditures are greater than the amount needed to sustain current dividends);
  • Five-year average dividend payout ratio (percentage of company’s earnings paid out as dividends) does not exceed 60 per cent;
  • Five-year net income volatility (standard deviation) is less than the S&P 500 average (21 per cent).

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What did we find?

Our screen yields 11 companies split across consumer staples and health care, which were the worst-performing U.S. sectors of 2016 at 2.9 per cent and minus 4.3 per cent, respectively. Although this was not part of our screening criteria, it is worth noting that the five-year beta is less than one for most of our results, indicating their price fluctuations have been less volatile than the market over the past five years.

This commentary does not provide individualized advice or recommendations for any specific subscriber or portfolio. Investors should conduct further research before investing.

Khaled Eniba works in the financial and risk unit of Thomson Reuters and specializes in banking and research.

U.S.-listed stocks with a history of low earnings volatility

CompanySymbolSector Market cap ($ Mil.)BetaP/EForward P/EDiv. yieldFCF YieldDiv. Payout Ratio (%) 5 Yr AvgNet Income 5-Year Volatility %
Johnson & JohnsonJNJ-NHealth Care316,343.40.7520.3816.312.8%5.00%54.5%10.8%
Wal-Mart Stores IncWMT-NConsumer Staples211,158.90.0914.9215.842.9%7.54%36.6%3.0%
Amgen IncAMGN-QHealth Care118,164.61.1615.8712.282.9%7.13%31.9%12.5%
CVS Health CorpCVS-NConsumer Staples87,128.10.8617.4313.932.4%6.94%25.0%3.5%
Anthem IncANTM-NHealth Care37,615.90.6716.7612.401.8%9.25%17.9%5.5%
McKesson CorpMCK-NHealth Care33,198.61.0616.4811.830.8%9.02%13.2%10.0%
Kroger CoKR-NConsumer Staples30,883.10.7815.6914.771.5%4.81%21.8%18.5%
Tyson Foods IncTSN-NConsumer Staples22,410.90.1613.8212.901.4%9.02%12.5%9.9%
J M Smucker CoSJM-NConsumer Staples14,904.80.5320.8616.052.3%8.43%49.2%14.8%
Quest Diagnostics IncDGX-NHealth Care12,814.50.6719.5716.941.9%4.27%25.2%15.0%
Universal Health Services IncUHS-NHealth Care10,817.41.1015.7213.820.4%5.93%6.5%3.6%

Source: Thomson Reuters Eikon

Khaled Eniba works in the financial and risk unit of Thomson Reuters and specializes in banking and research.