De­fen­sive stocks are com­pa­nies whose prod­ucts con­sumers can’t do with­out. In tough eco­nomic times, such stocks seem to be a no-brainer for in­vestors. But are these stocks re­ally such a safe bet?

Finweek English Edition - - FRONT PAGE - By Schalk Louw editorial@fin­

de­fen­sive stocks are preva­lent in in­dus­tries where com­pa­nies are mainly fo­cused on de­liv­er­ing cheaper prod­ucts or ser­vices that con­sumers find hard or im­pos­si­ble to man­age with­out. Typ­i­cal ex­am­ples of ar­eas in which de­fen­sive in­vest­ments can be found in­clude food man­u­fac­tur­ers and re­tail­ers, med­i­cal care and to­bacco sec­tors.

What makes these prod­ucts and ser­vices de­fen­sive in­vest­ments is the fact that they can­not be stopped or put on hold sim­ply be­cause the econ­omy is suf­fer­ing. And yes, the al­co­hol and to­bacco in­dus­tries are no ex­cep­tion. My grand­fa­ther al­ways used to say: “When food prices in­crease, peo­ple may buy a lit­tle less food. But when al­co­hol prices in­crease… they buy even less food.” Fur­ther, peo­ple must eat, and when they be­come crit­i­cally ill or in­jured, they must get med­i­cal help, re­gard­less of how much the econ­omy is suf­fer­ing.

De­fen­sive stocks are known for their abil­ity to with­stand pe­ri­ods of eco­nomic volatil­ity and mar­ket de­clines, but un­for­tu­nately, the op­po­site is also true. His­tor­i­cal data clearly shows that de­fen­sive stocks usu­ally strug­gle to keep up when the mar­ket thrives. On the other hand, busi­nesses such as car deal­er­ships, mo­bile phone providers, in­surance com­pa­nies and banks, which are much more sen­si­tive to mar­ket fluc­tu­a­tions, tend to ben­e­fit from a grow­ing econ­omy, but tend to suf­fer when con­sumers’ fi­nances are un­der pres­sure.

De­fen­sive stocks are sta­tis­ti­cally recog­nis­able due to the fact that they have a beta in­di­ca­tor of less than 1. In sim­ple terms, a stock with a beta of 1 means that for ev­ery per­cent­age point that the mar­ket rises or falls, your share/stock also moves up or down by the ex­act same per­cent­age. A beta of 0.8, there­fore, would mean that your share/stock will only rise by 0.8% for ev­ery 1% that the mar­ket rises, but that it will also only de­crease by 0.8% for ev­ery 1% the mar­ket de­clines.

I chose four ran­dom shares/stocks that could be clas­si­fied as de­fen­sive stocks, namely AVI (food man­u­fac­turer), Bri­tish Amer­i­can To­bacco, Net­care (med­i­cal care) and Spar (food re­tailer), and com­pared their rolling 12-month price move­ments to more cycli­cal com­pa­nies such as FirstRand, Im­pe­rial, MTN and San­lam. The re­sults were in line with the def­i­ni­tion of de­fen­sive stocks. They didn’t per­form as well as the cycli­cal stocks when the mar­ket thrived, but they shone brightly when­ever the mar­ket pulled back.

What con­cerns me is the fact that many in­vestors started to con­sider de­fen­sive stocks as a safe haven when in­ter­est rates started to en­ter an up­wards cy­cle about 18 to 24 months ago. The more con­cerned in­vestors be­come world­wide, and the higher mar­ket risks be­come, the more cycli­cal stocks are be­ing ex­changed for de­fen­sive stocks.

When we com­pare the four de­fen­sive stocks’ his­tor­i­cal price-to-earn­ings ra­tios (P/Es) to that of the more cycli­cal stocks, you will see that the av­er­age his­tor­i­cal P/E of de­fen­sive stocks was rel­a­tively close to the av­er­age his­tor­i­cal P/E of the cycli­cal stocks af­ter the great cor­rec­tion of 2008 (14.1 times). Seven years down the line, how­ever, these de­fen­sive stocks’ av­er­age his­tor­i­cal P/E is trad­ing at 22 times, com­pared to the cycli­cal stocks’ P/E of 13.3 times. My ques­tion is, how de­fen­sive are de­fen­sive stocks re­ally at these cur­rent boil­ing lev­els?

These ten­den­cies al­ways re­mind me of the lat­est diet trends. Un­til re­cently, fat was your worst en­emy, mak­ing car­bo­hy­drates the safer food op­tion. These days you’re al­lowed to stuff your­self with any­thing fatty while car­bo­hy­drates should be avoided at all costs. I’m not say­ing that de­fen­sive stocks are bad in­vest­ment op­tions, but a proper bal­anced diet has never hurt anyone.

Bri­tish Amer­i­can To­bacco To­bacco man­u­fac­turer

AVI Food man­u­fac­turer

Spar Food re­tailer

Net­care Med­i­cal care

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