It has been a volatile couple of days in the market as investors have recalibrated their expectations of how aggressively the Federal Reserve will raise interest rates this year to stamp out inflation. It’s a real cause for concern because a tightening cycle that prioritizes crushing inflation above all else will hurt the economic expansion, potentially sending the economy into a recessionary period and will ultimately hit the stock market.

However, we do not want to move completely to the sidelines out of fear of a Fed-mandated slow down because there is always a bull market somewhere, and it is our job to go find it and become more selective with what we own.

There is always a bull market somewhere

Do us a favor. Look at the charts of healthcare names like Pfizer (PFE), Eli Lilly (LLY), Abbvie (ABBV); consumer staples names like Costco (COST), Walmart (WMT). Then compare them with the charts of financial names like Wells Fargo (WFC), industrials like Boeing (BA), Ford Motors (F). 

What do the first group of stocks have in common? They are referred to as defensive names, because of their relatively recession-resistant nature, or in detailed explanation, their earnings are not very dependent on how well the economy is doing. Pfizer is a healthcare/drug company and the strength of the economy will not dictate whether consumers buy more or less medicine. 

On the other hand, the second group are economically sensitive companies, meaning their earnings are largely dependent on the economy. Take the banks for example. In an economic expansion period, people take a lot of loans, through which the banks can benefit from charging interest rates and fees. However, when the economy is slowing or contracting, people take less loans, therefore the banks do not earn as much money.

So you can see, at the index level, there may have been a lot of carnage, but underneath the surface, the defensive sector has been performing really well. As fears of a recession continue to dominate the market, we’re taking a page out of hedge funds' playbook, and adding a consumer packaged goods company that will do just fine if and when the economy hits a recession.

Procter & Gamble

Procter & Gamble (PG) owns a diverse portfolio of household products spread across five product categories: Fabric & Home Care, Baby, Feminine & Family Care, Beauty, Health Care and Grooming. The company’s brands are some of the best names in their categories, from Tide, Downy, and Gain laundry detergents, to Bounty paper towels and Charmin toilet paper, to Crest and Oral-B toothpastes, to Head & Shoulders and Herbal Essences shampoos, to Gillette razor blades.

Recession-resistant stock

We believe P&G is a safety stock and recession-resistant because demand for its products do not fluctuate based on the economy. People don’t stop buying toothpaste, toilet paper, paper towels, and laundry detergent in a slowdown.

The company could be a huge winner here as they have raised prices in anticipation of higher costs but we have learned this week that freight costs are plummeting, down 30% for the year according to some sources, and we may be seeing a peak in a variety of raw costs. When the Fed tightens it hurts the producers of raw goods not so much the consumers. P&G, which has dropped about 3% in 2022, should be ready for its next move higher

P&G is not completely immune to inflation and margins have come under pressure recently, but unlike many of its peers it has pricing power to pass on these higher input costs. The company has earned this ability over time by investing heavily in innovation — to make its products superior — and in advertising — to make sure everybody knows its products are superior.

In the company’s most recent quarter, it generated fantastic 6% organic sales growth, with half coming from higher volume and half coming from higher prices. Those price increases stuck across all five of their main business segments.

In a recession, one of the big fears one might have with a consumer packaged goods company is the risk that consumers trade down to lower quality brands due to pricing. We think management is well prepared for this scenario and on track to launch many new products this year focused on midtier offerings and more affordable pack sizes.

Shareholder returns

By now, you know how we feel about investing in companies in this turbulent market: We want companies that “make stuff or do things”, earn a profit for their efforts and return part of those profits to shareholders through dividends and buybacks.

Procter & Gamble belongs to a special group of stocks called Dividend Aristocrats, meaning they’re one of the S&P 500 companies that have increased its dividend every year for the last 25 years. In P&G’s case, the company has increased its dividend for 65 consecutive years. Currently, shares pay a quarterly dividend of $0.8698 (an annual dividend of approximately $3.48), good for a roughly 2.24% yield. Historically, P&G announces an increase to its quarterly dividend this month, so we expect some news soon. The company is set to report fiscal third-quarter 2022 earnings on April 20.

Additionally, the company has a massive share repurchase plan in place, buying back $4.8 billion of stock last quarter alone. Overall, P&G expects to repurchase $9 billion to $10 billion of its common shares in fiscal 2022.

Price-to-earnings valuation

As for the current price, P&G currently trades about $9 off an all-time high set this past January — and that’s a good thing, because we never want to chase. On valuation, shares are trading at 25.6x next 12-month earnings. This multiple is a couple of turns higher than the five-year average of 22.2x. 

Safety stocks are rarely cheap — and it’s for a good reason, because they are what work in a slowdown. Still, it represents a slight discount to the five-year max of multiple of 26.9x. Even in a market where multiple expansion is hard to come by, it would not surprise us to see P&G trade at an even higher multiple as investors rotate out of economically sensitive names and back into safety stocks that pay dividends and buy back stock.

We are initiating P&G with a 1 rating — meaning, we would be buyers at the current price — and an initial price target of $175, representing 26.5x estimated calendar year 2023 earnings.