Inflation remains stubbornly high, creating a new class of winning stocks
- Aggressive Fed rate hikes will continue, increasing the outperformance of must own stocks in this market.
- Toronto-Dominion Bank (TD): TD Bank is proving resilient as interest income grows due to rising interest rates.
- Dollar General (DG): DG stock has bucked the trends of a historically bad year for the market.
- Charles Schwab (SCHW): Schwab’s record quarter is a direct result of higher income boosted by higher rates.
- United Health (UNH): United Health is a logical defensive choice for investor capital right now.
- Walmart (WMT): Walmart has rebounded and provides a strong defensive fortress with plenty of upside.
- Southern Company (SO): A lull in price is a buying opportunity in this utility stock with a big dividend.
- BJ’s Wholesale Club (BJ): The discount club has strung together a series of strong quarters.
The Fed will continue its aggressive rate hikes into 2023, albeit at a slightly slower pace. Following a fourth-consecutive 75 basis point (0.75%) rate hike on Nov. 2, it now looks like the pace will slacken. Current expectations are that the central bank will increase rates 50 basis points when the Federal Open Market Committee adjourns in December. Thus, this is shaping up to be an interesting time for those looking for must own stocks in this environment.
Still, a lot remains to be seen before the Fed convenes on December 14-15. In particular, November inflation numbers will be released just prior to the meeting. Any negative surprise could quickly change the decision calculus of the Fed, and could potentially lead to another 75 basis point hike.
In short, investors should continue to expect an aggressive Fed and plan accordingly. Survival in this environment requires adherence to tried-and-tested strategies. Banks benefit from higher rates, and defensive stocks protect against the downside. Those must own stocks provide a great place to hide in this environment.
Toronto-Dominion Bank (TD)
Toronto-Dominion Bank (NYSE:TD) is a stock set to survive aggressive rate hikes for the simple reason that bank profit margins rise as interest rates increase. So, given the expected hikes ahead, Toronto-Dominion Bank should reliably price in this “good news” moving forward. As rates increase, banks increase the interest they charge on loans, thereby increasing income.
That has indeed been the case for TD Bank. Revenues were nearly stagnant, increasing slightly from C$10.712 billion in Q3 ‘21 to $CAD10.925 billion in Q3 ‘22. However, net interest income has risen during the same period, which can be directly attributed to rising rates. During the same period, interest income increased from $CAD 6.004 billion to $CAD 7.044 billion.
TD stock reliably benefits from predictably rising interest income. This results in higher overall revenue in times like these, when rates are on the rise. Therefore, TD stock should remain a strong performer into 2023 and beyond.
Dollar General (DG)
Dollar General (NYSE:DG) stock has had an exceptionally strong 2022. This discount retailer has appreciated in price by roughly 9% through Thanksgiving. Meanwhile, the S&P 500 has fallen more than 16% this year. The reason Dollar General is likely to continue to thrive is that 2023 rate hikes threaten to tip the balance of the economy.
What I mean is that the economy is precariously near the edge. The Fed’s previous moves have yet to produce their intended effects. Thus, rate hikes tend to produce lagging results, meaning a 2023 recession is far from out of the question.
Investors don’t need to dig deep into Dollar General’s fundamentals in order to understand why it’s a strong choice. Although the company’s fundamentals remain strong, it’s the macroeconomic situation that makes DG shares equally attractive. In short, consumers are increasingly drawn to the retailer’s offerings because discounts matter. Sales increased 9% in the previous quarter and aren’t likely to slow down as influential voices continue to predict an oncoming recession.
Charles Schwab (SCHW)
Charles Schwab (NYSE:SCHW) stock benefits from many of the same tailwinds that Toronto-Dominion Bank does. Namely, higher rates are proving to be a big benefit to earnings.
In fact, Charles Schwab’s recently posted Q3 earnings set a new record for the company. The $5.5 billion in revenues set a record, leading to adjusted quarterly earnings of $1.10, also a record. Wall Street had been expecting $5.4 billion in revenues and $1.05 in earnings.
Additionally, like TD Bank, Charles Schwab is experiencing rapidly-increasing net interest revenues. In Q3, those net interest revenues increased by 44% to a whopping $2.9 billion.
Another way Charles Schwab can help investors survive rate hikes is through the income it provides from its dividend. That dividend is yielding 1.07% on a forward basis and hasn’t been reduced since 1989. Investors can reinvest this dividend or use it for income. Either way, Schwab’s dividend provides a 1% return that can be especially helpful in tough times.
UnitedHealth (NYSE:UNH) is a leading healthcare stock, and as most investors know, healthcare stocks are commonly viewed as defensive picks.
While financial stocks are attractive in a rising rate environment, economic weakness can blunt any net interest gains. However, healthcare stocks thrive for a different reason. Namely, these stocks’ defensive nature. Healthcare stocks fare well because people require healthcare in every part of the economic cycle. Thus, UNH stock acts as something of a hedge against the worst effects of a downturn.
The good news for investors is that UnitedHealth stock still has plenty of room to rise. While many defensive stocks are fully priced, UNH shares have nearly 12% upside based on consensus target stock prices. UnitedHealth has also beaten analyst earnings per share expectations in each of the past four quarters and yet still has $70 of upside. Its defensive nature makes it a reasonable stock in which to park capital in these tough times. Furthermore, its dividend provides additional return beyond any share price appreciation.
Walmart (NYSE:WMT) has recently seen a nice rebound, which is one of the key reasons this is on my list of must own stocks to buy. For one, discount retail stocks tend to fare well as economic worries mount. Walmart is the country’s largest retailer by revenue and its discounted prices and strong purchasing power bode well for the company moving forward.
During the most recent quarter, Walmart’s comparable sales increased 8.2%. This fact is notable, considering the company is also the largest food retailer in the U.S. With food prices remaining stubbornly high, Walmart should continue to see grocery shopping foot traffic remain strong. In Q3, shopper visits to Walmart increased by 2.1% on a year-over-year basis.
Holiday retail sales are expected to grow by 6% to 8% this year, reaching $960.4 billion at the 8% level. Walmart will begin to benefit substantially beginning on Black Friday. The results of those sales won’t be known immediately, but investors should buy WMT stock, as this defensive play should remain strong in most economic scenarios moving into 2023.
Southern Company (SO)
Southern Company (NYSE:SO) is an electric utility company serving Alabama, Georgia, Florida, and Mississippi. Like healthcare, people need electricity no matter how bad the economy gets. Thus, Southern Company is a safe bet to continue to perform well for that reason.
The company also provides gas and fiber optic services to its customer base in addition to electricity. Again, consumer demand for those services tends to remain relatively steady, or inelastic, despite prevailing economic conditions.
SO stock is currently priced around $66. That is quite close to its average consensus target price of $68. That would seem to suggest that inventors hold off until there’s a lull in this company’s valuation. However, SO shares have traded above $80 recently and current prices likely represent that lull.
Further, Southern Company pays a very healthy dividend with a forward yield of 4.1%. It hasn’t been reduced since 1986, and patterns suggest that it will probably be increased by 2 cents, to 70 cents, sometime next year.
BJ’s Wholesale Club (BJ)
BJ’s Wholesale Club (NYSE:BJ) recently reported record earnings for its third quarter. The good news for investors is that despite the strong results, 12.3% upside remains based on consensus target prices.
Big box wholesalers including Costco (NASDAQ:COST) and BJ’s have had a strong 2022 as inflation has been particularly hard on grocery prices. As a result, consumers continue to buy in bulk in record numbers. Surprisingly, BJ stock remains far from target prices, which makes its appeal even greater.
The company’s Q3 earnings released Nov. 17 were very strong, with comparable sales jumping 9.7% year-over-year. Rising gas prices contributed to those strong numbers. However, even with the effects of gasoline stripped out, comparable sales increased by 5.3%.
And while comparable sales, which measure stores that have been open for 12 months or more, increased by 9.7%, overall sales grew by 12.3% in the quarter. This number was even higher through the first three quarters, at an even more impressive 17%. Through the same period, net income has grown by an outsized 20.2%. Accordingly, BJ stock looks to have been ignored this year, which makes it a great buying opportunity.
This post originally appeared at InvestorPlace.
On the date of publication, Alex Sirois did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.