Editor's Choice

Lower Risk Stocks as we Approach "The Cliff"

Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Finally, the election is upon us and we can all escape the political rhetoric SOON.  However, the feeling of relief may not last long as attention will quickly turn to the looming fiscal cliff and its impact on the economy and markets.  I recently highlighted why investors need to maintain an overweight position in equities; however, there are real risks that could have real consequences on one’s portfolio.  While I don’t foresee a bear market in equities, the possibility is certainly there.  Earnings will likely register their first decline in five years in the third quarter, the fiscal cliff looms, and the overwhelming headwind that political uncertainty is placing on business cannot be trivialized.  Instead of foolishly jumping ship to richly valued bonds, investors may well be suited to rotate into some safer equities for the next several months until the situation plays out.  Below are some stocks worthy of consideration in such a scenario.

Safety in Spirits

While there is likely no industry that is recession-proof, beverage stocks are certainly recession-resistant.  One name I have favored this year has been Beam (NYSE: BEAM).  The company has done an admirable job in its first year being independent from its former parent Fortune Brands.   Sales in the first nine months of the year have gained 5% and operating income has advanced 14%.  The company has a stable of key brands (Jim Beam, Maker’s Mark, Suaza, Skinnygirl) that was recently bolstered by the acquisition of Pinnacle Vodka.  The next several months should bring continued stability in operating results even if the economic landscape turns sour. 

The fourth largest spirits company in the world and second largest in the United States offers stable results and actually has more appeal now than when I highlighted at the start of the year.  We are one year closer to a potential M&A deal with industry leaders Diageo (NYSE: DEO) or Pernod-Ricard SA.  This makes an already solid stock investment a great one.  As I highlighted in my original piece, the valuation on a company that has real takeout potential is just fractionally higher than many of the safe stocks that investors flock to with zero buyout potential.   The upside is not priced into the stock.  The chart below shows that Beam trades just north of industry leader Diageo, which owns brands such as Johnnie Walker, J&B, Guinness, Smirnoff, Captain Morgan, Baileys,  and Jose Cuervo.   The same thing goes for traditionally safe Coca-Cola.  The chart also shows Beam’s manageable market capitalization that makes the 100% public company a viable M&A candidate in the next couple of years.


<img src="/media/images/user_36/beam-pic_large.png" />

What about Anheuser-Busch Inbev (NYSE: BUD)?  Funny you should ask.  This stock remains a solid investment, especially within the consumer staples space.  The company is one the best run in the world and since the merger has efficiently allocated capital, grown global market share from a leadership position, and continued to grind margins higher.  I penned a detailed description on the stock’s investment appeal and it certainly merits consideration in any investor’s portfolio.

Strong Demand for Commercial Mortgages

Starwood Property Trust (NYSE: STWD) is the largest commercial mortgage REIT with assets approaching $3 billion.  I highlighted it as a likely candidate to outperform at the onset of 2012 and it has delivered with a year-to-date total return of 33%.  The thesis continues to merit consideration as more than $1 trillion dollars in commercial mortgage loans are set to expire in the coming years.   Banks remain capital constrained, thus the void creates an opportunity for Starwood Property Trust and other mortgage REITS to provide capital to the space on favorable terms. 

Starwood Capital Trust does not seek to own the equity in the properties, just provide the capital and clip the fixed income coupons.  The company focuses on performing commercial real estate loans and uses a modest amount of leverage to achieve low double-digit returns.  The result is a very high dividend yield, currently at 7.6%.  This exceeds the Barclay’s High Yield Index despite offering considerably less risk and volatility.  Topping things off for this stock is the CEO, Barry Sternlicht, who is a pioneer in the industry and a key asset for equity owners.

With interest rates stuck at rock bottom territory, well run companies with dividend yields north of junk bonds should have a solid bid and offer downside protection in the event of a market correction.  Starwood Property Trust in one such company. 

Slow & Steady Wins the Race   

The next several months may well offer a rockier than expected ride for the stock market.  Ned Davis Research has pointed out that stock correlations are falling precipitously under QE3, a phenomenon that also occurred during previous episodes of quantitative easing.  This means outperformance isn’t all about timing risk-on or risk-off episodes, but rather identifying well run companies that offer compelling value.  One such winning strategy could be companies that offer the combination of top-notch leadership, lower volatility in their stock price, and 8-12% earnings-per-share growth.

market8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Beam. Motley Fool newsletter services recommend Beam, Diageo plc (ADR), and The Coca-Cola Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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