Four Defensive Stocks for a Market Pullback: MCD, MO, CAG, JNJ

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If you looked at just the first-quarter results you could be forgiven for thinking that everything in the stock market is rosy.

The Dow Jones Industrials and the S&P 500 turned in their best performances since 1998, rising 8.14% and 12.0%, respectively.

Meanwhile, the Nasdaq was even stronger, riding a tech-stock rally to a gain of nearly 19% – its best yearly start since 1991.

But as every seasoned investor knows, the markets never go straight up or straight down.

Prospects for continued strength may seem bright, but the recent five-day slide that took the Dow down almost 550 points might be pointing to something else entirely.

That's why now is the perfect time to consider shifting at least some of your funds into "defensive" stocks.

How to Shop For Defensive Stocks

The following criteria generally describe defensive stocks:

  • Those in non-cyclical industry groups, meaning they are capable of maintaining or increasing their revenues and earnings regardless of whether the overall economy is growing, flat or even slumping.
  • Companies that provide products or services in fairly constant demand, even when the economy slows. Examples include producers of consumer staples; food packagers and distributors; healthcare and pharmaceutical companies; suppliers in certain addictive "sin" markets, such as tobacco and alcohol; and essential utilities.
  • Those that have a recognizable brand name (or names) that consumers look for first, even when times are hard and cash is short.
  • Stocks that pay steady – and historically increasing – dividends, which can provide both income and a cushion against short-term drops in share prices.
  • Stocks with below-average volatility (beta) relative to the overall market, or a negative correlation with the primary business and/or market cycles.
  • And companies that have at least some international exposure, providing access to emerging markets that offer growth even when developed nations may be struggling.

Because of these characteristics, defensive stocks tend to outperform the rest of the market during economic downturns, and hold up better than growth stocks during market pullbacks – whether short- or longer-term.

Be aware, however, that they tend to underperform the market during major rallies or in periods of strong economic expansion, simply because demand for their "staple" products doesn't rise as much as it does for discretionary goods and services.

With that as a backdrop, you may want to shift some of your holdings to more defensive stocks if you feel a rising sense of uncertainty regarding the near-term future of the market or the overall economy.

Defensive Stocks for Uncertain Markets

Here are four defensive stocks to consider right now. They include:

  • McDonald's Corporation (NYSE: MCD): With its strong international reach, an ever-growing cadre of young domestic customers, a broader menu, major worldwide institutional support, steady revenue and earnings growth (to $5.27 per share for the trailing 12 months), and a dividend of $2.80 per share (yielding 2.8%), it's no surprise Mickey D's makes the list. Although the share price is up substantially from its low of $76.43 last June, MCD was fairly flat during the first quarter, resisting both upward euphoria and downward pressure. That stability should continue if the market fails to regain earlier momentum and begins a swoon into June.
  • Altria Group Inc. (NYSE: MO): Although you see "No Smoking" signs everywhere you go in the United States, the habit retains a strong hold on much of the rest of the world – and is even on the increase in some parts of Asia. That has kept revenue ($23.8 billion in 2011) and earnings ($1.64 per share) growing for this maker of Philip Morris cigarettes, cigars, smokeless tobaccos – and wine to drink while you're puffing. The company also has a large financial services division and a large portfolio of leveraged and leased properties – both agricultural and manufacturing – around the globe. The stock trades in a fairly tight range and is currently near its 52-week high. However, the dividend of $1.64 (a yield of 5.18%) will provide a nice cushion against a modest pullback.
  • ConAgra Foods Inc. (NYSE: CAG): If you think picking winning stocks is difficult, try finding a supermarket that doesn't have shelves loaded with ConAgra products. Brands include Banquet, Chef Boyardee, Egg Beaters, Healthy Choice, Hebrew National, Pam, Marie Callender, Del Monte (Canada) and many others. The company maintained steady growth through the recession and has since continued to expand both revenues ($3.37 billion in Q1-2012) and earnings ($1.90 a share in 2011) through a combination of acquisitions, broadened distribution and improved operating margins (10.87% in Q1 versus 9.96% in 2011). The stock trades in a very narrow range – from $22.20 to $27.34 over the past 52 weeks – meaning the 96-cent dividend (3.7% yield) will cover a big chunk of even a total retracement to last year's lows.
  • Johnson & Johnson (NYSE: JNJ): Move past the food sections of the supermarkets mentioned above and into the pharmacy and household-goods sections, and you'll find an equally dominant presence for the products of JNJ. The company operates 139 global manufacturing plants churning out both prescription and over-the-counter drug products, as well as numerous consumer products and medical and diagnostic devices, marketed under its own and other names. Revenues have averaged $16.2 billion per quarter for the last five periods, but earnings for the quarter ended April 3 climbed to $1.41 a share from $1.25 in the same period a year ago, largely because profit margins increased to 24.23% from just 14.87% for all of 2011. The stock stands about midway through its 52-week range ($59.08-$68.05) and the $2.28 dividend provides both a 3.6% yield and a substantial cushion against pullbacks.

One final note… If you feel nervous or uncertain about the future of the stock market but aren't quite ready to rearrange your portfolio you can always use options plays.

Check out last month's Money Morning article entitled: "How to Use Options to Hedge Against a Stock Market Correction."

Hedging your portfolio with options is a strategy that can provide some protection until you're sure a downturn is on tap.

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