You may want to keep individual stocks in your portfolio rather than depend entirely on global mutual fund managers to steer you through the world’s economic upheavals. If so, you might want to shift to “defensive” stocks that are well-suited to today’s environment.
It’s especially important to pick stocks that are resistant to the possible effects of Europe’s massive debt crisis spinning out of control. The financial turmoil already has cut into profits for many companies around the world and could lead to worsening recessions across Europe…trillions of dollars in loan defaults…waves of bank failures…and the collapse of the euro.
And it’s not enough to just avoid investing in the most vulnerable European stocks. The economic shock waves could spread across the globe, reaching China, the US and other countries that serve as global economic engines.
Bottom Line/Personal spoke with top financial strategist Elliott Gue about the kind of stocks that can provide a relatively safe haven amid all the uncertainty…
THE OLD DEFENSIVE STOCKS
Many savvy investors are shifting to defensive stocks, typically those from giant US corporations that make products that people will continue to buy even in a global recession. Owning these stocks can mute losses in your portfolio if the global situation continues to deteriorate but still allow you to participate in market rallies if Europe pulls back from the brink—something it has done several times in the past three years. Unfortunately, many classic defensive stocks that investors relied on in past recessions and crises—such as HJ Heinz and McDonald’s—may not hold up this time around. These companies and many others depend on Europe for a large portion of their revenues. And because the US dollar is so strong now relative to the euro, the euros that these companies do earn are worth less once they are converted back to dollars for financial-reporting purposes.
THE NEW DEFENSE
For defensive stocks that still are attractive, look for the following…
Modest exposure to Europe. The company should get most of its revenue from the US and emerging markets. Yes, those economies have slowed, too, but they still are relatively strong compared with most other nations.
Modest valuations. The company doesn’t have to be a bargain, but it should trade at a reasonable price. Many defensive stocks have become prohibitively expensive. In fact, seven of the 30 stocks in the Dow Jones Industrial Average reached record highs this year. Risk-averse investors also have bid up the prices of other safe-haven favorites such as utilities.
Solid balance sheet and a consistent dividend. I like companies that have increased their dividend in at least eight of the last 10 years.
Downside resistance. Make sure that the stock price has held up during the last US recession and in bear markets. It should have lost substantially less than the S&P 500 stock index lost in 2008.
Low beta. Beta is a measure of how volatile a stock is compared with the S&P 500. A beta of 1.0 means that the stock moves essentially in line with the index. A low beta means less volatility. For instance, a beta of 0.5 indicates that the stock is half as volatile as the S&P 500. (You can find the beta for a stock at http://Finance.Yahoo.com.)
My favorite stocks now…
Bristol-Myers Squibb Company (BMY). Pharmaceutical companies tend to hold up well through bad times because consumers don’t cut way back on prescription medicines. Bristol-Myers Squibb has the lowest exposure to Europe of the major US pharmaceutical giants and unusually low stock volatility. Its beta is just 0.22%, and the stock price dropped a mere 6.5% in the last bear market back in 2008, bolstered by a dividend that recently yielded 4.3%. Moreover, the company has taken several smart steps that will help insulate it from the expiration of drug patents and economic downturns in the future. These include selling off businesses unrelated to its core strategy of developing high-margin prescription drugs, especially cancer drugs, and creating cost-saving partnerships with other pharmaceutical firms to lower development costs and diversify the risks of the Food and Drug Administration approval process. Recent share price: $31.77.
Hillshire Brands Co. (HSH). This is a very attractive stock for the current environment. In June, the iconic American business Sara Lee spun off the riskier international parts of the company, retained its North American brands (including Jimmy Dean sausages, Ball Park hot dogs and Sara Lee baked goods) and renamed itself Hillshire Brands. It is now a safer, more focused version of the old Sara Lee, with a hefty dividend recently yielding 1.9%. Recent share price: $25.75.
Johnson & Johnson (JNJ). If I had to pick one company to hang on to through a European Armageddon, it would be the world’s largest and most diverse health-care company, which has dozens of leading consumer brands, such as Band-Aid, Sudafed and Tylenol. J&J has raised its annual dividend, recently yielding 3.6%, for the past 50 consecutive years. It’s only one of four corporations on the planet that still has a AAA credit rating, and its stock lost just 7.6% in the 2008 bear market. The biggest driver of earnings—the company’s prescription drug division—has a strong pipeline of new drugs and less exposure to patent losses in the next few years than any other major pharmaceutical firm. Recent share price: $68.32.
Kimberly-Clark Corp. (KMB). Like food and health-care companies, manufacturers of consumer-staple products have been in excellent positions to hide out in bear markets. Kimberly-Clark is a leader in the global health and hygiene category, with dominant brands that include Kleenex tissues, Scott paper towels, Cottonelle toilet paper and Huggies diapers, as well as infection-prevention products. Rising income and birth rates in emerging markets will help the company grow earnings by about 8% annually over the next five years. Add in a dividend recently yielding 3.6%, free cash flow of more than $1.5 billion in the first seven months of 2012 and a beta of just 0.08%, and the stock should be able to greatly outperform the broad market in troubled times. Recent share price: $82.85.
Nestlé SA ADR (NSRGY). A company headquartered in the heart of Europe seems like an unlikely defensive stock in case the European economy crumbles. But Nestlé, the largest packaged-good company in the world, with a wide variety of brands such as Nestlé hot chocolate, Gerber baby food and Purina Cat Chow, is misunderstood by many investors. It happens to be based in Switzerland, but it derives less revenue from Europe than many of its US competitors. That misunderstanding has kept the stock’s valuations reasonable. In the 2008 bear market, Nestlé’s returns beat the S&P 500 stock index by 25 percentage points. The company has increased its annual dividend payment every year over the past decade by an average of 12.5% per year. Recent share price: $62.44.