Cabot Dividend Investor Issue: April 12, 2023

Bank on a Megatrend in an Uncertain Market

This has certainly been a better year for the market than last year with the S&P 500 up 7% YTD. But there is still a lot of uncertainty, and this bear market may roar again.

Stocks have rallied in the weeks following the bank failures. So far, the banking situation has tempered the Fed without any offsetting crisis. The Fed went from indicating several more rate hikes to just one more and then it’s done. That means we’re now farther ahead in the cycle which expedites the recovery timeline.

The Fed stopping rate hikes is a relief to investors. But now there are increasing expectations of a recession later this year. While fretting about Fed rate hikes may be over, the new worry is a recession.

We still don’t know the timeline, severity, or duration of a possible recession. It will be difficult for stocks to muster a sustainable rally before investors can sniff out an economic bottom. And that may be many months away.

We don’t know if we will be dealing with recession, inflation, or stagflation over the next year. During times where there is so much we don’t know, let’s focus on what we do know. We know that dividend stocks historically outperform the market in such environments, especially those of companies in defensive industries. We know something else too.

The population is aging. And it’s doing so at warp speed. A third of Americans are already age 50 and older. And the fastest growing segment of the population is 65 and older as an average of 10,000 baby boomers have been turning 65 every single day for the past 12 years and will continue to do so for the rest of this decade.

The human demographic is changing before our eyes. The population of the country and the world is already older than ever before in human history, and the trend is accelerating. It makes a huge impact because baby boomers control more than 70% of the wealth in this country and they are demanding health care like crazy.

It makes sense to opt toward defensive stocks with so much uncertainty and a recession possibly looming. But if you can find a stock that is defensive and also has the tremendous tailwind of a megatrend, it’s even better.

It’s not a coincidence that the two top performing stocks in the portfolio are health care companies Eli Lilly (LLY) and AbbVie (ABBV). In this issue I highlight a defensive dividend stock likely to endure future market turbulence that is also a Dow component and a goliath in the health care industry with a history of market-crushing returns.

What to Do Now

The market is changing. It is moving on from the high inflation/hawkish Fed conundrum that caused last year’s bull market to a new concern about recession. Peril remains. But its stripes are changing.

The market is already reacting. The best performing sector so far this year is technology, one of the worst performing sectors last year. Falling inflation and interest rates, which should continue in a recession, have rallied the sector. The recovery timeline in the technology sector may be ahead of that of the overall market. And it may have already begun.

In addition, defensive stocks have been moving higher since the bank failures. Defensive stocks had lagged the market in the early part of the year. But the new recession concern has made them popular again. Utilities and health care have been among the top performing sectors again over the last month.

Defense should remain king because the looming recession concern is unlikely to fade anytime soon. That’s the reason the portfolio is still very defensively postured with a high cash allocation. However, technology stocks could continue to outperform the market as the issues that drove those stocks lower last year are abating.

The current BUY-rated stocks are all defensive, with the exception of Visa (V) and its unusual properties. It’s still a little early to recommend more cyclical stocks as the market faces too much risk of another painful downturn in the months ahead. The technology stocks have been moving higher but still have not been upgraded to a BUY and won’t until they show resilience in a slowing economy.

Featured Action:

Buy UnitedHealth Group Incorporated (UNH) Yield: 1.3%

UnitedHealth Group (UNH) is a Dow Jones component that is America’s largest insurer and one of the world’s largest private health insurers. It’s a goliath with $324 billion in annual revenues that serves 149 million members in all 50 states and 33 countries. That’s a lot of monthly insurance premiums!

The company operates in two primary groups, UnitedHealthcare and its Optum franchises. UnitedHealthcare provides health insurance and benefits to a wide range including large national employers, public sector employers, mid-sized employers, and small businesses and individuals. It also provides health insurance for Medicare and supplements as well as employers globally.

The Optum franchise provides direct health care, technology services, and prescription drug solutions. The direct health care includes an alliance with 70,000 physicians in local medical groups as well as ambulatory care systems and other chronic treatments. The technology provides data and analytics to manage complex administrative and regulatory issues with hospitals and physicians. It also provides a full spectrum of pharmacy care services.

The group provides services at just about every facet of the health care process and the full-scale operation provides a powerful alignment of incentives that helps clients control costs better than competitors, which is a massive issue in the industry.

It’s also a huge company and operation. Scale is hugely important in this industry. It enables UnitedHealth Group to keep costs down by virtue of volume, have cash for acquisitions, and wield significant power to adjust rates as prices increase. That’s a huge benefit during inflation.

But talk is cheap. How has this massive and comprehensive operation reflected in stock performance? Here’s a look at various returns over the past 10 years (as of April 11) compared to the market, as measured by the S&P 500.

Although UNH is large in scale, the stock has managed to blow away the returns of the overall market, with roughly twice the return over the past three- and five-year periods, and quadruple the return over the last 10 years. UNH has also done this with considerably less volatility than the market, with a beta of just 0.69.

Sure, UnitedHealth has the huge tailwind of the aging population, as explained above. But so do many other stocks in the health care sector. I chose UNH because it has also been a consistently strong performer. It has significantly outdone its peers as well as most large health care stocks of any stripe.

The Dividend

UNH currently pays a quarterly dividend of $1.65 per share, or $6.60 annualized, which translates to 1.3% yield at the current price. While that’s a subpar yield, the payout is well supported with just a 30% payout ratio and the dividend is likely to grow. In fact, the quarterly payout has grown 120% over the past five years, from $0.75 in 2018 to the current $1.65. Companies that grow their dividend tend to be the best market performers as a group over time.

Looking forward

Health care is a highly recession-resistant business as people tend not to postpone health issues in any economy. UnitedHealth Group is a large, safe business that provides stability in uncertain markets. Aside from that, it has the massive tailwind of the aging population and an ever-increasing number of customers.

Enrollments were up 1.2 million last year and are forecast to grow by a million again this year. Because of a solid balance sheet, reliable revenues, and deep pockets, the company is able to grow through acquisitions. It recently acquired a cutting-edge software company that should give it a further advantage in streamlining processes and saving costs.

Last year was a bear market and the S&P 500 was down 19.4% for 2022. UNH was up over 5% for that year and earnings per share (EPS) grew 18.3% for the calendar year versus 2021. It is a great safe haven and the company forecasts mid-teens EPS for at least the next several years while average S&P 500 earnings are forecast to shrink for the second quarter in a row.

UNH is never going to be your biggest winner, unless you hold it forever. But it will be a safe port in an impending storm. It will increase earnings during an earnings recession for the overall market. It will provide defense and growth at the same time while never providing a high level of risk. It’s a great pick for the current times.

UnitedHealth Group Incorporated (UNH)
Security type: Common stock
Sector: Healthcare
Price: $516.71
52-week range: $449.70- $558.10
Yield: 1.3%
Profile: UnitedHealth Group (UNH) is a Dow Jones component that is America’s largest insurer and one of the world’s largest private health insurers.

Positives

• UnitedHealth has the size, scale, and expertise to thrive in a defensive yet growing industry.
• Earnings are expected to grow by mid-teens annually for the next several years.
• UNH is a blue-chip defensive stock at a time when a recession is approaching, a period that has historically been one of relative outperformance.

Risks

• UNH could be nicked in a recession as the number of employees paying premiums diminishes.
• This is an industry that is at the mercy of the latest government regulatory whims.

UnitedHealth Group Inc. (UNH)
Next ex-div date: June 10, 2023, est.

Recent Activity

March 22
SOLD Medical Properties Trust, Inc. (MPW) - $7.40

April 12
Buy UnitedHealth Group Incorporated (UNH)

Current Allocation

Stocks 30.2%
Fixed Income 20%
Cash 49.8%

Portfolio Recap

Enterprise Product Partners (EPD – yield 7.4%) – There’s good news and bad news, rallies and selloffs. There’s inflation and talk of recession and recovery. The market changes personality month after month, and even week after week. But EPD just continues its slow slog higher. EPD also returned 18.4% in 2022 when the S&P was down 19.4% for the year. It’s up another 12% YTD this year. It also has a high yield and earnings that are resilient in inflation and/or recession and should continue to be a winning formula for the rest of this uncertain year. (This security generates a K-1 form at tax time). BUY

Enterprise Product Partners (EPD)
Next ex-div date: April 27, 2023

ONEOK Inc. (OKE – yield 5.8%) – It’s been a bouncy ride to nowhere so far this year. But OKE is still up slightly YTD. It hasn’t been a great year so far for more defensive stocks or energy. But that may change as recession becomes more likely later this year. OKE had been pulled down in the wake of the banking situation, but has recently more than made up the decline. This company continues to post strong earnings and is well suited to endure inflation or any kind of economic slowdown that might be coming down the pike. It should be a solid performer over the rest of the year. BUY

ONEOK Inc. (OKE)
Next ex-div date: April 28, 2023, est.

Realty Income (O – yield 4.9%) – In a highly uncertain environment like this, where the narrative can change on a dime, income is king. And this legendary income REIT is the king of income stocks. It has paid 632 consecutive monthly dividends and increased the dividend payment 119 times since its IPO in the 1990s. And the REIT has been growing stronger through acquisitions of late. Realty should be solid in the event of recession. Despite being a retail REIT, the portfolio is largely staple properties like drug stores and supermarkets that are resilient in a slower economy. HOLD

Realty Income (O)
Next ex-div date: April 30, 2023, est.

The Williams Companies, Inc. (WMB – yield 6.0%) – WMB has been a struggling stock this year because of natural gas prices, which have crashed. Although the company is not highly levered to energy prices, it is affected by turbulence in its industry. Prices have fallen largely because of the unusually warm winter temperatures throughout the country and the world. Demand has been far less than anticipated and stockpiles have built up. But it is a temporary problem for a fuel source that should own the next decade. And WMB has gotten cheap ahead of a period of what should be relative outperformance. BUY

Williams Companies, Inc. (WMB)
Next ex-div date: June 10, 2023, est.

AbbVie (ABBV – yield 3.7%) – This is a transition year for AbbVie as its mega-blockbuster immunology drug Humira faces a U.S. patent expiration. Sales of $20 billion in annual revenue for the drug are estimated to drop 37% this year and company revenues are expected to decline in 2023 as a result. But this has been seen by the market a mile away and this year’s patent expiration is already factored into the price, which is at a very cheap multiple compared to its peers.

Meanwhile, AbbVie has one of the best pipelines in the business and its pipeline is capable of making up the shortfall relatively quickly. Its two newer immunology drugs alone (Rinvoq and Skyrizi) are expected to generate $17.5 billion in revenue in 2025 and $21 billion in 2026. It’s encouraging that the stock has been trending higher since September and indicative that the expiration is already priced in, and investors are looking ahead to a bright future. The stock is even YTD and if it continues to get through this year in good shape, it should be off to the races after that. HOLD

AbbVie Inc. (ABBV)
Next ex-div date: April 13, 2023

Broadcom Inc. (AVGO – yield 2.9%) – This has been a rough time for technology stocks. Since the environment soured at the beginning of 2022, AGO has had a total return of -1.66%. That’s resilient of a stock in a sector that is under siege. AVGO was added to the portfolio because it is a highly resilient technology company that is mostly involved in technology infrastructure and earnings are not highly dependent on product sales.

Things are also improving in the sector as inflation and interest rates have been trending lower. Technology is the top performing sector YTD, up about 20%. AVGO is up 13% YTD and 50% since the low of last October. It seems like the worst is over and this stock should perform very well as the sector continues to recover. HOLD

Broadcom Inc. (AVGO)
Next ex-div date: June 21, 2023, est.

Brookfield Infrastructure Partners (BIP – yield 4.5%) – The infrastructure juggernaut has been bouncing around to nowhere since the end of 2020. The uninspired returns aren’t that bad considering it has been a bear market. The stock had been held back more recently by a strong dollar and higher lending rates, but those things have been receding and the stock might be on the move. BIP recently hit the highest price level since last fall and is up about 11.5% YTD. The stock is now right around the midpoint of its 52-week price range and should be a solid holding amid inflation and/or recession. (This security generates a K-1 form at tax time). BUY

Brookfield Infrastructure Partners (BIP)
Next ex-div date: May 28, 2023, est.

Eli Lilly and Company (LLY – yield 1.3%) – LLY was upgraded to a BUY last month and has since moved sharply higher and may be approaching a new high. After a stellar 2022 where it returned 34% in a bear market, LLY pulled back early this year. But it was unlikely to stay down for long. Lilly grew earnings 12.7% in 2022 and is expected to grow earnings by an average of 22% per year over the next five years. It also has two drugs that could be mega-blockbusters in the pipeline that could be approved in the next year. The longer-term trajectory is strong and it made sense to buy the dip, especially ahead of a possible recession. BUY

Eli Lilly and Company (LLY)
Next ex-div date: May 14, 2023, est.

Intel Corporation (INTC – yield 1.5%) – INTC has leveled off this month but not before an impressive move off the low. The stock price soared more than 30% in the month of March and broke out to the highest level since last summer. Part of it is a rally off the bottom as the stock sunk to book value after lousy earnings and guidance and a dividend cut. Intel is still a powerful industry player and its recent attempts to catch up to its competitors should succeed to a least some degree over time. The company also appears to have solved its production issues, which bodes very well for new products on the launchpad and a sooner return to profitability. HOLD

Intel Corporation (INTC)
Next ex-div date: May 4, 2023

Qualcomm Inc. (QCOM – yield 2.4%) – This is a great longer-term stock of a company with a huge share of mobile 5G chips and strong exposure to some of the fastest growing areas in technology. Meanwhile, it sells at a very cheap valuation by historical standards. QCOM has been pushed around by the sector since it’s been under pressure but there has been new life lately. Inflation is coming down and interest rates are falling and technology is the best performing sector YTD with the group up more than 20%. At some point this year, the market should start sniffing out the recovery, if one hasn’t already begun. And QCOM can make up for lost time fast when it moves. HOLD

Qualcomm Inc. (QCOM)
Next ex-div date: June 1, 2023, est.

Visa Inc. (V - yield 0.8%) - V is tied to the fortunes of the more cyclical stocks in the near term. But it tends to outperform that group. It held up nicely in a very tough 2022 with a -3.4% return for the year, it’s up over 30% since the September low, and it has a better than 9% return YTD. Of course, it could be under pressure if the economic situation deteriorates. But the stock is still relatively cheap, and it should fly when the market eventually senses the end of this cycle and the next recovery. BUY

Visa Inc. (V)
Next ex-div date: May 9, 2023, est.

NextEra Energy (NEE – yield 2.4%) – This combination regulated and clean energy utility stock has struggled YTD, down 6%. But it was resilient in last year’s bear market. The truth is that defensive sectors have lagged so far this year while technology and consumer discretionary stocks have been the best. It’s likely because of a rebound or a reversion to the mean. But NEE is still well positioned as a defensive stock with growth in a highly uncertain market where a recession is becoming more likely. BUY

NextEra Energy Inc. (NEE)
Next ex-div date: May 23, 2023, est.

Xcel Energy (XEL – yield 2.9%) – Yeah, this clean energy utility stock got knocked around a little bit in the tough market for defensive stocks in the early part of this year. But defensive stocks are springing back as a recession later this year becomes more likely. Utilities and health care have been among the top performing sectors over the past month. XEL won’t be held down for long and has already started moving higher. It’s up over 12% in the last month. And with a recession possibly looming, XEL should remain a good place to be. BUY

Xcel Energy Inc. (XEL)
Next ed-div date: June 14, 2023, est.

USB Depository Shares (USB-PS – yield 5.3%) – This preferred stock has bounced around with interest rates since being added to the portfolio, moving lower when long-term interest rates rise and vice versa. But interest rates have plunged since the banking problems and increasing fear of recession and this stock has moved higher again. The 10-year rate seems to top out around 4% and then pull back. BUY

U.S. Bancorp Depository Shares (USB-PS)
Next ex-div date: April 15, 2023, est.

Invesco Preferred ETF (PGX – yield 5.8%) – Longer-term rates are bouncing around and have recently been moving lower again. It is still a good time to buy this preferred ETF and the stable income provides a cushion in tough markets and rates may come down further if the economy weakens as expected. BUY

Invesco Preferred ETF (PGX)
Next ex-div date: April 24, 2023, est.

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 4.4%) – There could be some near-term turbulence with the price on the way to solid longer-term returns and diversification. The increased risk of a recession this year bodes well for the near-term total return of this fund. BUY

Vanguard Long-Term Corp. Bd. Index Fd. (VCLT)
Next ex-div date: May 1, 2023, est.

Dividend Calendar

Ex-Dividend Dates are in RED and italics. Dividend Payments Dates are in GREEN. Confirmed dates are in bold, all other dates are estimated. See the Guide to Cabot Dividend Investor for an explanation of how dates are estimated.

The next Cabot Dividend Investor issue will be published on May 10, 2023.