With stock markets extending last week’s losses, investors could reduce their risks by shifting into defensive shares. Having a mix of defensive and cyclical shares in your investment portfolio could help to reduce the volatility of your investment returns and protect your capital.
Although no share is unaffected by changes in the economic conditions or the state of the stock market, some companies are more resilient and less affected by them. Defensive companies rely on a business model that allows them to deliver stable earnings and cash flows over the business cycle. Usually, defensive companies have high dividend yields and can be found in the utilities, consumer non-cyclical, healthcare and defence sectors.
One of the simplest methods for identifying defensive or non-cyclical shares is looking at their betas. Beta is a measure of how responsive a particular share is to wider movements in the stock market index. Shares with a beta of less than 1 tend to move less strongly with changes in the market index, and shares with a particularly low betas are usually classified as defensive shares.
Here are three defensive shares that may be worth considering:
National Grid (LSE: NG) shares have a beta of 0.32 over the past five years, which means a 1% change in the market usually only has the effect of moving shares in National Grid by 0.32%. Although most utility companies are defensive in nature, National Grid is particularly defensive because of its focus on the regulated electricity transmission and gas distribution businesses.
The majority of its revenues comes from these regulated businesses, and these revenues come from levies and tariffs paid at levels determined by the regulator Ofgem, by utility suppliers that use its networks. But this also means National Grid faces regulatory uncertainties and the company is unlikely to see rapid earnings growth.
Valuations in the company are attractive, though. Shares in National Grid currently yield 5.0%, and it has a P/E of 14.7. National Grid also plans to raise its dividend by at least RPI inflation each year “for the foreseeable future”.
Shares in GlaxoSmithKline (LSE: GSK) could be described as somewhat less defensive, as its shares have a five-year beta of 0.64. Demand for pharmaceutical products and consumer healthcare products are non-cyclical, and so the nature of the healthcare sector means that GSK can reliably generate stable earnings and cash flow to pay its dividends.
On the downside, GSK is exposed to blockbusters that have lost patent protection or will soon be losing it. Underlying EPS has declined over the past three consecutive years, but management expects earnings will recover in 2016, as it has a strong pipeline of 40 new drugs. Management has frozen its dividend at 80 pence annually until 2018, and GSK shares currently yield 6.0%.
BAE Systems (LSE: BA) has a five-year beta of 1.00, but it could still be described as a defensive company. The levels of defence spending is relatively unaffected by changes in the real economy. Global political stability, the level of terrorism threats and geopolitical tensions are better determinants of defence spending.
The company has been hit hard by cuts to defence budgets in North America and Europe, but analysts see a bottoming in the market. Underlying EPS is expected to bounce back by 1% to 38.2 pence this year, with growth accelerating to 6% for 2016. Shares in BAE Systems currently yield 4.6%.
