Stocks to reinforce your portfolio against volatility

The historic low levels of volatility have helped equity markets grind higher over the past few years. However, as the stocks hit new highs and benchmarks balloon to record levels, there is a growing concern the market may be veering dangerously close to bubble territory.

Indices like the S&P 500 are led by volatile sectors such as technology -- the largest constituent of the index -- that are prone to sharp downturns, triggering turbulence that can quickly spread to other sectors.

Therefore, although equity market volatility has been the lowest in a decade, this may be an opportune time for investors to make some portfolio adjustments and hedge against potential market turmoil that can impact their portfolios. Bargain hunters may want to keep a close eye on stocks as widespread market selloffs tend to turn up great buying opportunities.

Stocks with strong financials and durable competitive advantages tend to weather the market storm better than others. Some of these stocks are trading at a sizeable discount to their fair value, and they have wide economic moats and strong fundamentals. They could be attractive options to consider for those looking to reinforce their portfolios against volatility and other vagaries of the stock market, according to Morningstar equity research.

A leading player in the global snack arena,  Mondelez (MDLZ) owns many household brands including Oreo, Chips Ahoy, Halls, Trident and Cadbury. Its portfolio comprises biscuits (41% of sales), chocolate (30%), gum/candy (15%), beverage (5.5%), and cheese and grocery (8.5%). The firm derives one third of revenue from developing markets, nearly 40% from Europe and 24% from North America.

Mondelez is a stalwart in the global packaged foods industry. The company boasts a strong brand mix (seven brands generate more than US$1 billion in annual sales each), and a vast global presence, according to a Morningstar report.

With a 15% share of the global chocolate market, and an industry-leading 18% worldwide market share in the biscuit category, Mondelez is a valued partner for retailers seeking brands to drive store traffic, says the report.

Morningstar sector head Erin Lash forecasts strong returns on invested capital over the next five years, an indication of the firm's robust competitive advantage. "The strength of the firm's edge is evident in its adjusted returns on invested capital that we forecast to exceed 16% by fiscal 2021, exceeding our 7% weighted average cost of capital estimate," she says.

The company is also pushing hard to crimp costs. "We expect Mondelez's cost savings to ramp up to its target of US$1.5 billion this year but expand to US$2.5 billion in fiscal 2020, 65% of which we forecast will drop to the bottom line," says Lash, who appraises the stock's value at US$50 and projects net profit margins will expand to 17% by 2018, reaching 20% by 2026.

A global coffee chain with almost 26,200 stores in 70 countries,  Starbucks (SBUX) sells coffee, espresso, teas, cold blended beverages, food and accessories. The company also distributes packaged juice and pastries through its own stores and grocery store chains, as well as bottled beverages and ice creams through various partnerships.

"We view Starbucks as one of the most compelling growth stories in the global consumer space today, poised for top-line growth and margin expansion through menu innovations, sustainable cost advantages and evolution into a diversified retail and consumer packaged goods platform," says a Morningstar report.

The coffee chain's international growth opportunities, particularly in China, India, Japan and Brazil, are indisputable as the company can apply best practices from the U.S. to these regions to accelerate its growth aspirations, says Morningstar sector strategist, R.J. Hottovy.

Management's 2017 targets include 2,100 new store openings (implying 8% unit growth), global comparable-store growth in the mid-single digits, and adjusted operating margins of about 20.2%, up from 19.9% in 2016.

Longer-term forecasts assume 2,200 annual new store openings over the next 10 years, with an estimated 47,700 stores globally by 2026 (6% annual unit growth), with consolidated operating margins reaching 24% over the same period.

Despite its ambitious growth plans, Starbucks can sustain a 45%-50% dividend payout ratio over the next 10 years, implying mid-teens average annual dividend growth, says Hottovy, who recently raised the stock's fair value estimate from US$66 to US$70, incorporating a 2018 price/earnings ratio of 28 times, enterprise value/EBITDA of 16 times, and a 3% free cash flow yield.

The world's largest consumer products manufacturer,  Procter & Gamble (PG) owns non-food products such as Tide, Charmin, Pentene and Pampers, well-known brands used in millions of households around the world. The business generates 60% of its total sales outside the United States, a third of which from emerging markets.

"P&G's strategic actions over the past few years [like trimming its brand portfolio] indicate it is parting ways with its former self to become a more nimble and responsive player in the global consumer product arena," says a Morningstar report.

Of the 65 brands now in its portfolio, 21 generate US$1 billion to US$10 billion in annual sales and another 11 that account for US$500 million to US$1 billion in sales each year. These brands already account for more than 85% of the firm's top line and 95% of its profits.

Additionally, P&G is working to extract US$10 billion in costs by reducing overhead, lowering material costs and increasing manufacturing and marketing productivity, says Lash, who assesses the stock's value at US$94, incorporating a price-to-2018-earnings ratio of 23 times and an enterprise value/EBITDA of 16 times.

The wide-moat company enjoys substantial cost advantages inherent in its size and scale and in the stickiness of its retailer relationships. "Trusted manufacturers like P&G, with a product set that spans the grocery store, are critical to retailers that are reluctant to risk costly out-of-stocks with unproven suppliers," says Lash.

Morningstar's long-term projections show the firm's ROIC to continue to exceed its cost of capital over the next 20 years, and operating margins growing to nearly 25% by 2026 from 21% in 2016.

 Emerson Electric (EMR) specializes in large-scale automation systems for process-oriented heavy industries, including oil and gas, refining, chemicals and power. The firm recently divided its business operations into two segments: automation solutions and commercial & residential solutions.

Emerson remains significantly exposed to the oil and gas industry at nearly 50% of consolidated sales, says a Morningstar report, noting that "patient, long-term investors will be rewarded as oil prices recover."

Morningstar equity analyst Barbara Noverini says: "Emerson is one of the few global players that excel in the large automation project arena, and this type of work hasn't come back yet in full force."

The segment, she asserts, will capture a nearly 16% share of the fragmented global automation market, "placing emphasis in process automation where Emerson has historically been a leader."

The firm's commercial & residential solutions business too is expected to ride the resurgent U.S. building and construction markets. "Near term, climate technologies are well positioned to benefit from strengthening U.S. construction markets, while longer-term opportunity exists in emerging markets needing infrastructure development," Noverini notes.

The wide-moat company gains its competitive edge from customer switching costs, cost advantage and intangible assets, and boasts a history of consistent mid-teen returns on invested capital.

"That returns remained well above the cost of capital during a period that included one of the more difficult global recessions in recent history, followed by a severe downturn in oil prices, speaks to the staying power of Emerson's portfolio," says Noverini, who recently upped the stock's fair value estimate from US$62 to US$66.