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How effective are defensive stocks?

How effective are defensive stocks?
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First Published: Thu, Nov 15 2007. 12 00 AM IST
Updated: Thu, Nov 15 2007. 12 00 AM IST
The best form of attack is defence. Or, so the saying goes. Shares of beverage, tobacco and other consumer staples companies—all classic safe havens—have performed well amid the troubles elsewhere on Wall Street in the past few months. But the “Cokes and smokes” thesis only goes so far. Shifting money to defensive names in times of turbulence is hardly a novel strategy, and rising prices for companies in this sector suggest that further upside is limited.
Even so, demand for daily essentials such as shampoo and toilet paper ought to remain fairly steady even in the face of plunging markets. Many of these companies operate on a global scale and can tap into fresh sources of demand in emerging markets.
Also, the credit panic—and its impact on the financial and manufacturing sectors—has led investors to focus on consumer staples. The S&P 500 group that tracks this sector has beaten the broader index over the past month. Personal products, soft drinks, household products and tobacco have led the charge. Not surprisingly, most financial groups have lagged the index, and home-builders have plunged by nearly one-third.
But safety doesn’t come cheap. As investors seek shelter in these names, the values of the companies have swelled accordingly. Consumer-sector stocks trade at more than 21 times trailing annual earnings. This is nearly a 25% premium to the S&P 500 overall, according to data from Reuters Knowledge. To justify that premium, earnings growth for consumer companies would need to outpace the broader market by about 5 percentage points a year for the next five years.
It’s not impossible, but there’s not much room for disappointment. Sure, these companies have defensive business models. But their margin of safety looks to be thin. Because of this, consumer-sector stocks may no longer be the safest place to take shelter.
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First Published: Thu, Nov 15 2007. 12 00 AM IST