With the stock market reaching all-time highs in 2024, some investors might be feeling uneasy. Inflation remains elevated, and concerns persist about the economy potentially slipping into a recession, especially if the Federal Reserve maintains high interest rates for an extended period.

In such uncertain times, investors often seek more defensive stocks. However, developing a sustainable investment strategy is prudent regardless of market conditions. Given the volatility of stocks, identifying safer investment options can help make your portfolio more resilient during downturns.

How to find safer stocks to invest in

Finding safer stocks to invest in may seem daunting, but it becomes more manageable with a systematic approach. Knowing what to look for simplifies the process. Additionally, the best online stock brokers typically offer stock screeners that make it easier to identify safer investment options.

1. Consider companies with larger market caps

Larger companies are often safer stock picks due to their diverse revenue streams, economies of scale, and substantial financial resources. They typically allocate more funds for research and development and advertising, attract top talent, and maintain superior distribution networks compared to smaller competitors.

While no company is a completely risk-free investment, large-cap companies tend to be more resilient. Their robust business fundamentals and access to cheaper financing provide them with a stability that smaller companies may lack.

2. Pay attention to valuation multiples

Valuation multiples are metrics used to evaluate a company’s financial performance and its stock’s relative value. Common valuation multiples include the price-to-earnings (P/E) ratio, price/book ratio, and dividend yield. Discrepancies in these numbers compared to industry peers can indicate whether a stock is overvalued or undervalued.

For instance, a high P/E ratio suggests that a stock’s price is high relative to its earnings. However, because some industries typically have higher P/E ratios than others, comparisons should be made within the same sector. The same principle applies to other valuation multiples, such as the dividend yield.

In challenging economic times, investors often gravitate towards value stocks rather than growth stocks.

3. Target non-cyclical businesses

If a business is cyclical, it is likely to experience volatility during economic downturns because consumers often reduce their spending. For example, companies in the entertainment and travel industries typically struggle more during recessions. Consumer discretionary companies also tend to perform poorly when people need to tighten their budgets.

Conversely, people are less likely to cut back on essential expenses like utilities and healthcare. The state of the economy usually doesn’t impact whether individuals pay their electric bills or visit the doctor. As a result, these are considered non-cyclical industries.

4. Find companies with increasing dividends

Consistently increasing dividends indicate that a company is financially stable and moving in the right direction. The most resilient companies can raise their dividends even during recessions. These companies often belong to non-cyclical industries, such as consumer staples and pharmaceuticals.

A good place to find such resilient companies is the list of Dividend Aristocrats. These companies have maintained and raised their dividends for at least 25 consecutive years. While this criterion alone doesn’t make them a buy, it provides an excellent starting point for further research.

5. Look for companies with a sustainable competitive advantage

Competitive advantage is less quantifiable than other metrics but is equally important. Companies with strong brand loyalty or unique, patented processes or products often fall into this category. Brands that define entire industries typically possess a competitive advantage. For example, Apple is one of many companies with this edge.

Risk factors to watch out for

Investors must watch out for risks when looking for safe stocks:

  • Penny stocks: Stocks selling for under a dollar per share might seem like a great opportunity because you can buy hundreds of shares for little money. However, penny stocks often represent troubled companies in danger of going under or slowly fizzling out.
  • Unprofitable companies: Companies that don’t make money aren’t always bad investments. Startups in developing industries may have negative profits for several years before becoming profitable. If successful, they can reward investors with high growth rates. However, these new industries can also be unstable and unpredictable, making them less suitable for safe investments.
  • Unsustainable dividends: High dividends can be tempting for those seeking consistent payouts but can also be a warning sign. If a company pays out a high percentage of its earnings as dividends, it might not be sustainable. This may not apply to REITs, which are required by the SEC to distribute at least 90 percent of taxable earnings to shareholders as dividends.
  • Companies with too much debt: High levels of debt can be worrisome, especially in highly cyclical industries. Companies with high debt-to-capital or debt-to-equity ratios can be risky and may not be the safest investments, at least in the short term.

In Conclusion

Economic uncertainty often prompts investors to seek safer stocks. Large-cap companies with favorable valuation multiples and those in non-cyclical industries, such as consumer staples or utilities, tend to be more stable choices.

However, be wary of companies with high debt loads, unsustainable dividend payments, and lack of profitability, as these can indicate potential risks. While no stock is entirely risk-free, focusing on companies with strong fundamentals and avoiding these red flags can help make your investments more secure.