Large defensive stocks can offer relatively low risk exposure to the long term compound growth of stock markets. Their income stream in the form of dividends is a further reason to hold them as part of a diversified porfolio.
But what are defensive stocks?
Definition of a Defensive Stock
Defensive stocks are non-cyclical stocks, whose sales and business performance are not highly correlated with the overall economic cycle.
Not only do they generally produce solid earnings irrespective of the state of the larger economy, they also tend to offer higher-than-average dividend yields.
This can sometimes be because they service basic human needs or addictions, hence why defensives picks can be found in sectors such as food and drug retail, telecommunications, utilities, healthcare and pharmaceuticals, beverages and tobacco.
For an investor seeking income and relatively defensive exposure to the stock market, the following FTSE 100 stocks offer both a decent yield and are considered to be fairly valued at present, while offering relatively attractive long-term prospects.
Diageo
This global maker and distributor of premium branded spirits and beers has a wide economic moat. As with our previous two names (and, indeed, most of the market), the stock is also deemed to be fairly valued at present. Morningstar has a fair value estimate of 1,700p a share. In a recent report, Morningstar analyst Thomas Mullarkey commented on Ivan Menzies’ replacement of Paul Walsh as chief executive: “We continue to believe that Diageo (DGE) maintains an exemplary level of corporate stewardship and think that the transition to Menezes will be relatively seamless.”
Any weakness in its share price could offer an attractive opportunity to purchase a premium stock paying a prospective dividend of 2.7% for the year ending June 30, 2014.
GlaxoSmithKline
Pharmaceutical company GlaxoSmithKline (GSK) offers investors exposure to global growth in healthcare, a wide economic moat and diversified earnings. As such it is hardly surprising that Morningstar analysts have a fair value estimate of 1,777p.
In contrast to AstraZeneca (AZN), Glaxo has not been adversely affected by the so-called ‘patent cliff’, the expiry of old patents leading to reduced profits as generics enter the market. Prospective investors should note, however, that Astra is currently carrying a 4-star rating from Morningstar analysts, implying the stock is slightly undervalued at present.
For the year ending December 31, 2013, consensus estimates are for Glaxo to achieve pre-tax profits of £6.9 billion, putting it on a forward price/earnings ratio of 14. It also offers a juicy prospective yield of 4.77%.
Tesco
The UK’s largest supermarket has fallen out of favour recently, under pressure from falling profits.However, this needs to be put in context. Consensus estimates for the year ending February 28, 2014 are for Tesco (TSCO) to record pre-tax profits of approximately £3.4 billlion, putting the stock on a lowly forward price/earnings ratio of 10.17.
Its recent share price fall brings it below Morningstar’s fair value estimate of 386p a share. The stock is not without risks but for investors seeking exposure to retailers, it is currently Morningstar’s preferred European-based multinational retailer. The stock currently delivers a chunky dividend of 4.5%.
Vodafone
Following the agreement to acquire Kabel Deutschland for EUR 7.7 billion, Morningstar analyst Allan Nichols has maintained a fair value estimate of 198p a share for Vodafone (VOD).
With its global reach and diversified earnings streams, thanks to its 45% stake in Verizon Wireless, Vodafone seems to offer defensive qualities and scope for decent shareholder returns over the medium term. Part of this is likely to come from capital appreciation, but it also offers holders a prospective dividend yield of 5.5% for the year ending March 31, 2014.
Disclosure: The author holds shares in Tesco and Vodafone.
