Horizon.my

Not too long ago in 2007, stock market analysts were highly bullish on Bursa Malaysia. The KLCI was nearing 1,500 points and corporate earnings particularly in the Palm Oil and Banking sectors were looking rosey.

A year on and everyone’s talking global recession. Earnings forecasts are slashed and stock valuation multiples have tumbled. My how times have changed!

I must admit I was on the bull bandwagon… and suffering the consequences now.

I am holding on to stocks which have declined 30% or more in the past few months. So now I’m sitting back and thinking to myself… what could I have done better in picking stocks for my portfolio?

Defensive Stocks

Investorwords defines a defensive stock as one which tends to remain stable under difficult economic conditions usually in the food, tobacco, oil and utilities industries.

Defensive companies supposedly hold up better in hard times because demand for their products and services do not decrease as much compared with other companies. However the flip side is that defensive stocks also tend to lag the rest of the market during an upswing.
 
Recently JP Morgan came out with a list of 16 stocks to hold in a two-year global recession.
 
“There is growing demand from clients for core holdings that outperform in a global recession… every week that passes that credit markets remain challenged, there’s incremental damage to the macro economy.”

JP Morgan’s key criteria for defensive stocks are:

• Low debt levels
• Return of cash to investors in the form of dividends or buybacks
• Profitability
• Able to prosper in a global slowdown

The 16 companies they identified are:

3M, Baxter International, Colgate-Palmolive, CA Inc, Devon Energy, General Mills, Gilead Sciences, Google, Hewlett-Packard, McDonald’s, Merck, Monsanto, Nucor Philip Morris, Union Pacific Corp, Visa Inc.

In Malaysia we don’t have an equivalent for most of these companies. But we have some tobacco companies, infrastructure and utility companies which may fit the bill as defensive stocks:

British American Tobacco
BAT has been paying out more dividends than what it earns every year for the last 5 years. As a result it is running down its Shareholder Funds while gearing has crept up. Earnings have actually been flat and declining slightly over that period, I guess people are still smoking as much as before. In short BAT is not a good growth stock but if you had held it for the last 2 years you’d be pretty happy. Just goes to show that if management cannot find what to do with the spare cash, they should just give it back to shareholders. It helps too if the parent is a foreign company because dividends is how they take money back to their home country.

Petronas Dagangan
PETDAG is the petroleum marketing and retailing arm of national oil company Petronas. Although oil price is volatile, PETDAG’s sales volume is not significantly affected by cyclical fluctuations because its inventory cost and selling price are regulated under an Automatic Pricing Mechanism. It has strong net cash position and pays healthy dividends hence it qualifies as defensive.

Plus
Most infrastructure and utility companies in Malaysia are geared to the tilt and Plus is no exception. Yet it fits the bill as defensive because it is a monopoly and everyone has to use its highways.

Public Bank
Banks are generally regarded as a proxy to our economy and the bank widely considered to be the strongest and most resilient is PBBANK. While all the other major banks are bogged down with poor acquisitions and capital market woes, PBBANK continues to power on with no apparent cracks in its business. But those who bought at RM12 may not be too happy for now.

Star Publications Berhad
Newspapers are not considered defensive in the US. Ad revenues are plummeting because of the web and also the carnage in the auto and financial sectors which are major ad spenders. Newspaper companies that are moving into the web are finding it tough… welcome to the real world of perfect competition! The Internet really levels the playing field. But I’ve put Star Publications into the defensive basket because Malaysia is different from the US. Star has been a steady performer, in a strong cash position and conservatively managed. Too conservatively perhaps. I would have loved to see Star do some Internet acquisitions in Malaysia but it hasn’t happened yet. If they don’t get it right, there will be some serious threats to their business 10 years from now.

There are probably a few more stocks that can be considered “defensive”. Check out the table below:

Note:
1. High price is measured from 1/1/07 to 5/12/08.
2. The following counters pay out more dividends than what they earn: BAT, BJTOTO, CARLSBG (incl special), DIGI (incl special), GUINESS, JTINTER (incl special), NESTLE, PBBANK.

PORTFOLIO DIVERSIFICATION

Admittedly my portfolio would have performed much better over the past year if I had a defensive stock component in it. Just look at the table above… on average you would have lost less than 20%, while the broader market has lost 45%. Not much consolation but if you are working for an institution, you would be beating your benchmark by miles and getting a nice fat bonus.

Blessed are they that laugh at themselves, for they shall never cease to be entertained.
Chinese Proverb

I only have one defensive stock which is PETDAG. But when my portfolio gets big enough in the future, I will put more defensive stocks in it. And pay myself a nice bonus when the market falls  

While I am learning to be more like Warren Buffet in being a Focused Investor, diversification is still important.

Look at what King Solomon had to say about it:

Give portions to seven, yes to eight, for you do not know what disaster may come upon the land.
Ecclesiastes 11:2

So the concept of diversification is found in the Bible too… isn’t that cool?