Recession Is Here. I'm Buying These 4 Dividend Stocks To Prepare

[view original post]

RomoloTavani/iStock via Getty Images

The signs of recession are very alarming which now has me convinced that a U.S. recession, and likely a global recession, is right around the corner. Given that the Nasdaq Composite is now officially in a bear market it appears that investing over the next 12-24 months is going to be challenging.

Data by YCharts

To prepare my portfolio for these circumstances I have been turning my focus toward attractively valued dividend stocks with revenues that are resistant to recessionary forces. Additionally, I am employing covered call option strategies to maximize the probability of positive return. I’m not only looking to beat the market, I want to earn healthy positive returns.

There are four stocks that have made the cut so far and I have opened long positions in each. These picks include Verizon Communications Inc. (VZ), Omega Healthcare Investors, Inc. (OHI), British American Tobacco p.l.c. (BTI), and Bristol-Myers Squibb Company (BMY).

Recession Is Sneaking Up On Us

One can never be certain of the future, especially a future recession. It does no good to frequently “cry wolf” and proclaim that a recession is imminent every year when clearly it is not. However, the data is stacking up and therefore my confidence is rising. Let’s take a brief look at the evidence.

To begin, retail sales have been increasing with strength. A decline or significant slow down in retail sales is often a sign of recession, as we can observe during the 2001, 2008, and 2020 recessions.

Data by YCharts

However, when we adjust retail sales for inflation, using the producer price index, we find that retail sales have already been in decline since 2021. This suggests that the U.S. may be entering recession.

Federal Reserve Economic Data | FRED | St. Louis Fed

Similarly, U.S. real GDP growth has gone negative. This is often correlated with a spike in recession probability, although the probability has yet to move today.

Data by YCharts

The U.S. unemployment rate is very low today at around 3.6%. Unfortunately, this level of unemployment has preceded each of the last three recessions. Low unemployment is not a cause of recession but the correlation in combination with all other factors is a concern.

Federal Reserve Economic Data | FRED | St. Louis Fed

Now it gets interesting. Two of the strongest correlations to recession is the change in oil price and yield curve inversion. Not all yield curves have inverted recently, however, many have including the 10Y minus 2Y treasury curve. There is some debate about how long the curve must remain inverted but what can be ascertained is that the last four recessions were preceded by inversions. To compound the issue, oil prices have surged dramatically. This is also a common prelude to recession, as was observed in 2001 and 2008.

Charts by TradingView

After a brief rebound in 2021, consumer sentiment resumed its decline. Sentiment levels are nearing those reached in 2009 during the depths of the great recession.

The Daily Shot (used with permission)

The yield curve inversion has been short this time, which may indicate a false signal. But if not, it is forecasting trouble ahead for equity markets which usually suffer their most volatile cycles following yield curve inversion.

The Daily Shot (used with permission)

Therefore, I am choosing my positions carefully. I’m looking for positions that will weather the recession but also perform well if there is not a recession.

Call For Backup – Verizon Communications Inc.

Verizon is trading at a blended P/E of 8.58 following the recent decline in share price in response to lower forward guidance. This compares to its normal P/E of 14.71. During the recessions of 2008 and 2020 share price declined. However, VZ was overpriced going into the 2008 recession, priced at 19x earnings, and revenues maintained through each recession. The stock hit a low valuation of 10x P/E during the 2008 recession, higher than the current multiple.

FAST Graphs

VZ pays a forward dividend of 5.5% with a robust dividend history of 18 consecutive years, including through two recessions. The dividend is currently well covered at a 46.8% payout ratio. The dividend receives positive overall grades from Seeking Alpha and is a solid high yield by my assessment.

VZ Dividend Score (Seeking Alpha)

To maximize probability of returns I’m employing a covered call strategy on this position. I’m starting with the May 20, 2022 50 Strike calls which earn a 5.6% annualized yield. If I wanted to lock in the yield for a longer duration I would go with the August 19, 2022 52.50 Strike for an annualized yield of 2.4%.

Chart by author, data from TD Ameritrade

Retire with Grace – Omega Healthcare Investors, Inc.

Omega is trading at a blended P/FFO of 8.08. The stock has been trading poorly over the last year due to continued non-payment of rent by several operators. Despite the challenging conditions I expect the company to persevere and continue its long term track record of success. Normal P/FFO for OHI is 12.47. During the 2008 recession share price was volatile and FFO took a slight dip of 8.5% but overall the performance was adequate for the circumstances. Shares traded to a low of 8.16 P/FFO.

FAST Graphs

OHI pays a forward dividend of 10.5% and although dividend growth has been lacking recently the company has avoided a dividend cut for the last 16 consecutive years. The forward AFFO payout ratio is 99% which is uncomfortably high. There is a serious risk that the dividend will need to be cut. However, I think such a cut would be temporary and I don’t need a 10% dividend for this trade to be attractive to me. This is what CFO Robert Stephenson said on the subject during the last earning call:

Consistent with how we’ve talked about it in the past, to the extent we’re working through these restructurings, but we have a view that long-term cash flows are going to — not going to be impacted or the impact is minimal, then I think we’ll be consistent with our dividend policy. And I guess the best example of that is Gulf Coast that we had.

We have $30 million of rent, which in Q1, we’re not going to collect any rent because they’re in bankruptcy. But we’re going to redeploy those assets by selling them, and we’ll end up with, call it, $300 million net that we’ll redeploy.

So the ultimate resolution on the Gulf Coast situation is a push from a cash flow perspective. And I think to the extent that some of these other restructurings end up in that same realm and there’s no reason to jump forward and say, “Hey, we’re going to change our dividend policy. But as everybody on this call knows, it’s an evolving environment. We’re going to be as transparent as we can.

What I’d say today, the policy is the same, unless we see a long-term impact on our cash flows, we’re not changing the dividend.

Seeking Alpha only grades the dividend yield which is very high.

OHI Dividend Grades (Seeking Alpha)

To maximize probability of returns I’m employing a covered call strategy on this position. I’m starting with the May 20, 2022 28 Strike calls which earn a 6.7% annualized yield. If I wanted to lock in the yield for a longer duration I would go with the September 16, 2022 30 Strike for an annualized yield of 3%.

Chart by author, data from TD Ameritrade

Don’t Let Profits Go Up In Smoke – British American Tobacco p.l.c.

British American Tobacco is trading at a 9.24 P/E. This compares to a normal P/E of 14.16. During the 2008 and 2020 recessions share price traded down 45% and 40%. But the shares started 2008 at a 18.3x P/E multiple and 2020 at 10.5x. Earnings in 2008 declined 14.4% but quickly recovered. At the bottom of the 2008 recession the shares traded at 11x P/E.

FAST Graphs

BTI pays a forward dividend of 7.09%. The dividend has had an erratic history since 2015 but the long term compound dividend growth rate is 9.5%. The “D” grade from Seeking Alpha for consistency is well deserved but I think the safety and growth grades are overly harsh. The high dividend payout ratio of 66.9% is intentional because the dividend is a priority for the company.

BTI Dividend Grades (Seeking Alpha)

To maximize probability of returns I’m employing a covered call strategy on this position. I’m starting with the May 20, 2022 45 Strike calls which earn a 4.2% annualized yield. If I wanted to lock in the yield for a longer duration I would go with the September 16, 2022 50 Strike for an annualized yield of 1.5%.

Chart by author, data from TD Ameritrade

Keep Your Portfolio Healthy – Bristol-Myers Squibb Company

Bristol-Myers Squibb is trading at a 9.92 P/E. This compares to a normal P/E of 18.07. Earnings continued to grow through the 2008 and 2020 recessions although the share price traded down. BMY traded at a 2008 low P/E multiple of 7.7x.

FAST Graphs

BMY pays a forward dividend of 2.87% with 15 years of consecutive dividend growth. Dividend grades from Seeking Alpha are all top class for BMY. The cash dividend payout ratio is a respectable 28.8%.

BMY Dividend Grades (Seeking Alpha)

To maximize probability of returns I’m employing a covered call strategy on this position. I’m starting with the May 20, 2022 80 Strike calls which earn a 4.9% annualized yield. If I wanted to lock in the yield for a longer duration I would go with the September 16, 2022 50 Strike for an annualized yield of 3.8%.

Chart by author, data from TD Ameritrade

Summary

With signs of recession abound it’s time to adjust my portfolio. Instead of aiming for home runs I’m focusing more on base hits to increase the probability of positive returns. These four dividend equities present an opportunity to earn double digit returns without relying on share appreciation. They include companies with revenues that are resistant to recession. This, in combination with attractive valuations, limit the downside risk. The covered call strategy is designed so that if my shares get called I will be happy to take my profits and redeploy the capital on the next trade.