Is the AI Rally Over? 3 Defensive Dividend Stocks to Rotate Your Profits Into

Quick Read

• Atmos Energy (ATO) is the largest natural-gas-only distribution company in the U.S. The company operates through regulated rates for natural gas distribution.

• McDonald’s gained 8.59% in 2008 and has not posted a red year in the past decade.

• Waste Management saw a $60M revenue drop in its recycling division due to declining recycled commodity prices.

• Some investors get rich while others struggle because they never learned there are two completely different strategies to building wealth. Don’t make the same mistake, learn about both here.

There is a subtle tone shift in how analysts and some retail investors view the market, as more people believe the AI rally has transformed into a bubble. Even if you don’t share that view, it is always a good idea to hedge, and defensive dividend stocks like Atmos Energy (NYSE:ATO), McDonald’s (NYSE:MCD), and Waste Management (NYSE:WM) are great for doing just that.

In the meantime, AI stocks are continuing to rally. Nothing yet indicates a slowdown if you look at the stock market. But once you take a look at the balance sheets of the companies spearheading the AI trend, it shows a worrying trend: cash on their balance sheet is decreasing, and depreciation is increasing. Why? Hyperscalers are buying extremely expensive GPUs for AI training, and these GPUs are also depreciating. GPUs have a very short useful life of about 3 to 5 years.

Still, some investors have an interesting angle on the AI rally. They acknowledge we are in an AI bubble, but they believe the bubble will inflate a lot more before it bursts. They cite the 1996 “Irrational exuberance” quote from the then-Federal Reserve Board chairman, Alan Greenspan. The Nasdaq Composite ended up rallying by ~285% through 2000 before finally crashing.

Could we be staring down a similar rally in the coming years? Maybe. Nonetheless, it’s silly to have no ballast in your portfolio.

The following defensive dividend stocks can play that role.

Atmos Energy (ATO)

Atmos Energy is the largest natural-gas-only distribution company in the U.S. This company solely deals with the transportation of natural gas, so you don’t have to worry about natural gas or energy prices.

Of course, a crashing economy will lead to energy stocks declining. But the good news is, utility companies like Atmos Energy operate through regulated rates for natural gas distribution. Atmos is likely to be quite resilient during recessions or downturns, as natural gas is essential for its customer base.

The stock has performed exceedingly well year-to-date, up 28.45%. The margins are strong, and free cash flow has grown 30.5% annually over the past 3 years. Future revenue growth estimates put annual growth at around 11.7% over the coming years.

Admittedly, ATO stock is rather expensive at the moment. Investors have been piling in for safety, and the financials are solid. I still expect it to be a great defensive holding as utilities are outside the purview of tariffs and are also seeing a rise in demand.

ATO stock yields 2.25%. Plus, it is a Dividend Aristocrat, with 40 consecutive years of dividend hikes.

McDonald’s (MCD)

McDonald’s has been one of the most reliable and dependable stocks to buy and hold in the past two decades. MCD stock powered through 2008, being one of the only few names to actually post gains that year. It gained 8.59% in 2008, and there hasn’t been a single red year in the past 10 years.

The secret behind that performance is that McDonald’s gains more appeal when times are tough. Even in 2020, when most restaurant businesses were hit particularly hard, McDonald’s managed to eke out an 11.3% gain, followed by a 27.79% gain in 2021.

It gets you a 2.4% dividend yield today, with a dividend payout ratio of 59%. The 3-year dividend growth rate is 8.9% annually, with another 1.3% average share buybacks annually over the past 3 years. Dividends have grown for 48 consecutive years. The free cash flow margin is over 28%, which is better than almost 97% of businesses in the restaurant industry.

And finally, McDonald’s staying power is enormous. It’s very unlikely to lose its relevance over time.

Waste Management (WM)

It should be easy to understand why Waste Management is likely to endure and keep generating cash. As you may have guessed, this company does waste management, but it is not limited to just that. It does waste recycling and sells these recycled products to manufacturers for reuse.

Most people pay for their waste disposal either directly through fees billed by municipalities or private providers, or they indirectly pay through property taxes and utility bills. These are not discretionary fees, and customers often have to pay no matter what. Most states make it illegal for municipalities not to have proper waste disposal services. And for the end customer, it is a trivial cost to fret about.

Thus, WM stock should continue climbing over the long run. WM stock has corrected recently, but the fundamentals remain healthy. Recycled commodity prices have declined and led to a $60 million revenue drop in the recycling division. This is beyond Waste Management’s control and is expected to be resolved with time.

I see the dip as a great entry point. You get a 1.5% dividend yield to sweeten the deal. The payout ratio is 44.36%, with the 5-year dividend growth rate at 8.47% annually. There have been 21 consecutive years of dividend growth.