3 Recession Stocks to Consider

Key Takeaways

• Many of the stocks that we’ve been watching this past week initially sold off when earnings came out, but then a lot of those stocks actually traded up over the course of the trading day.
• Alphabet GOOGL trades at about a 39% discount to our fair value, Amazon.com AMZN trades at about a 30% discount to our fair value, and Meta Platforms META trades at well over a 40% discount to our fair value.
• Finding defensive stocks that would hold up in a downturn is important for investors today.

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Every Monday morning, I sit down with Morningstar chief U.S. market strategist, Dave Sekera to discuss one thing that’s on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead. Dave, we’re in the thick of earnings season, and we have a lot of key mega-cap stocks reporting this week. But before we get into that, what do you make of earnings season so far? What are your key takeaways?

Dave Sekera: Good morning, Susan. I’d say there were definitely a couple of notable misses. I think Intel INTC probably being the one that I would highlight the most, but I’d say generally, I don’t think earnings have necessarily been all that bad, although we are certainly hearing anecdotal commentary coming out of the company that things definitely slowed during the quarter at the very end of December. But more importantly, for valuations, I’d say guidance has really been softer than expected, really due to that macroeconomic slowdown.

Now, it’s interesting. Many of these stocks that I’ve been watching this past week, they initially sold off when earnings came out and people guided down, but then a lot of those stocks actually traded up over the course of the trading day. I’m thinking that may indicate that the market has already been accounting for some of this soft-term economic weakness, and I think Microsoft MSFT is a prime example of that.

So, I think that it supports our view. Stocks are generally undervalued, but I do think that they’re going to have a hard time maintaining that rally that we saw last week until we really start seeing leading economic indicators begin to turn positive later this year. But really this week, and as you noted with the big mega-caps coming out, I think that’s going to be key as far as how the market behaves for the next couple months.

Dziubinski: Let’s talk a little bit about this coming week. We have some prominent companies reporting Alphabet, Meta platforms, and Amazon. What does Morningstar think of these stocks in particular today? And what impact might their results have on the market this week?

Sekera: Alphabet and Amazon, I think they’re the third- and the fourth-largest by market cap in the Morningstar US Market Index. And Meta itself, even though it’s still quite low compared to where it’s been in the past, it still has a $400 billion market cap. And so, based on their size, any swings in their price, up or down, certainly has an impact on the broad market indexes as well as investor sentiment. So, taking a look at those three, we think all three are undervalued. Alphabet is a 5-star-rated stock, trades at about a 39% discount to our fair value. Amazon a little less undervalued at a 4-star rating, but again, trades at about a 30% discount to our fair value. And then, lastly, Meta probably one of our more differentiated views in the marketplace today. It’s a 5-star-rated stock, and it trades at well over a 40% discount to our fair value.

Dziubinski: Also this week, Dave, you say you’re keeping an eye on some real economy stocks that are reporting. Tell us what a real economy stock is, and what you’re looking for.

Sekera: There’s really no definition of what a real economy stock is. It’s really just the way I think about it. But again, stocks of those companies actually make or build things, companies that have heavy construction equipment, things that make machinery, but again, companies that actually build things is what I think about.

For example, this week we have a whole host of those companies coming out. We have Caterpillar CAT, Dover DOV, Johnson Controls JCI, Honeywell HON, Illinois Tool Works ITW, Eaton ETN. I’m going to be listening to their guidance and really just trying to get from their viewpoint how much is the real economy slowing, yeah, how much is it impacting their businesses, and if I can really understand from their guidance, how long do they think the slowdown is going to last.

Dziubinski: Let’s move on to a new piece of research from Morningstar this week. And it’s related to Apple, which also reports this week. Morningstar recently upgraded Apple’s economic moat rating and boosted its fair value estimate a little bit. First, let’s talk about that economic moat rating. It went from being a narrow-moat stock to a wide-moat stock. What drove that change?

Sekera: Well, Morningstar does regularly review all of our moat ratings that we assign to every company under our coverage. And for those that may not be familiar with the economic moat concept, in my view, it’s really a Warren Buffett-type analysis to determine if a company generates excess returns today, how long will it be able to generate those excess returns before they get competed away. So, a company that we assign a narrow moat is one that should generate those excess returns for at least the next 10 years, and a wide moat is expected to generate excess returns at least 20 years.

During that recent review of Apple AAPL, the committee has really just become much more comfortable that a combination of those long-term sustainable durable advantages will last even longer than our initial views. Those being of switching costs, intangible assets, and the network effects associated with the IOS ecosystem. And so, in our view, we do think that Apple will be able to generate those excess returns for the next 20 years.

Dziubinski: Let’s talk a little bit about that fair value increase. We increased it a little bit. What was behind that?

Sekera: We did bump up our fair value estimate by 15%. So, our fair value on that stock right now is $150 a share. And essentially what that increase represents is that’s the increase in the present value of those excess returns that we forecast the company will earn now over a longer period of time than before.

Dziubinski: Dave, as we mentioned, Apple reports this week. What impact, if any, might the earnings report have on Morningstar’s view of Apple? Or is our view so long-term in nature that there’s little Apple could say that might change it?

Sekera: Well, it’s always subject to change, but I would say it’s highly unlikely that any one individual earnings report would impact our assessment of a company’s economic moat. Inherently an economic moat really is a very long-term outlook. However, I would say that depending on how earnings come out and what their guidance is, we could either raise or decrease our fair value if there are changes in the underlying business fundamentals that cause us to revise our projections for the long term.

Dziubinski: Let’s move on to the last part of our segment: your stock picks of the week. This week, you’re focusing on some undervalued defensive stocks that could hold up well during a recession. And your first pick is Clorox CLX. What do you like here?

Sekera: As you noted, our economics team is forecasting that the U.S. economy will either be stagnant or even possibly recessionary in the first half of 2023. And so, finding these more defensive stocks that would hold up in a downturn I think are important for investors today. So, the first one, Clorox, is rated 4 stars. It does have a wide economic moat, trades at a 15% discount to our fair value, and it currently pays a 3.4% dividend yield. And as you would imagine, sales did skyrocket yield know during the pandemic, and they are now slowing, and inflation is putting short-term pressures on margins. However, in our view, I think the market is soft the slowdown in revenue as the company is up against those heightened year-over-year comparisons. And then, growth trends will continue to normalize over the next couple of years.

In addition, as far as inflation goes, the company is raising prices. They are implementing efficiency measures to combat inflation. So, both of those, the price increases, and those efficiency measures, will help bring their margins back up over time.

Dziubinski: And then, your second pick of the week is from the utilities sector, it’s Dominion Energy D. Tell us about it.

Sekera: Well, you have to think about with utilities, I’d say generally speaking, there’s some of the most defensive companies out there. There really is not much of a change in their underlying business from economic contractions and expansions. And we do think that earnings growth will be relatively stable over the long term. So, Dominion is currently rated 4 stars, has a wide economic moat, and trades at a 20% discount to our fair value, and it also, currently pays a nice healthy 4.3% dividend yield.

Dziubinski: And then, lastly, we have a consumer’s defensive name that we all know, Kellogg K. Why is this one of your picks?

Sekera: I like Kellogg. Kellogg’s rated 4 stars, has a wide economic moat, trades at about an 18% discount to our fair value, also pays a pretty good dividend at 3.5%. And to some degree, I’d say Kellogg is a similar story with Clorox as far as the year-over-year comps and the pressures on the margins. But one of the attributes I find most compelling about Kellogg is that it does have one of the strongest portfolios of brands out there, and the faster-growing emerging markets at about 25% of its sales.

Dziubinski: Well, Dave, thanks for your time this morning. Always good to see you.

Be sure to join Dave and I live on YouTube every Monday morning at 8:30 a.m. Eastern, 7:30 a.m. Central. And while you’re at it, subscribe to Morningstar’s channel.

Have a great week.

Watch “What to Expect From Stocks in 2023″ with David Sekera.