Is it time to bank some gains in the defensives? We’ve seen the shares of defensive firms enjoy a good run up over recent years. At today’s 3,668p, consumer goods multinational Unilever (LSE: ULVR) is up around 184% since 2009. Energy transmission system operator National Grid (LSE: NG) is up 121% since 2010, and cigarette manufacturer and distributor British American Tobacco (LSE: BATS) has put on 214% since 2009.
Valuation spikes
Valuations look full. Unilever trades on a forward price-to-earnings (P/E) ratio of 23 for 2017, National Grid’s forward P/E rating is almost 18, and British American Tobacco’s is just over 19. The fallen pound seems to have caused a sharp up-spurt in these firms’ share prices as foreign trade becomes worth more when converted to pounds. When I see sharp moves up on a chart after a long period of steady rising, it makes me think that it’s time to consider taking some money off the table.
Such patterns on a share price chart can potentially end up looking like blow-offs and could presage change ahead. Maybe the relative weakness in the pound will reverse. Maybe global growth will slow. Many things could alter the steadily rising pattern with which we’ve become familiar for these shares.
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Valuations move in cycles
One driver for the defensives’ high valuations is that such firms become popular during times of uncertainty and we’ve seen plenty of that in recent years. However, the valuations of defensive companies can move in cycles. Should the macroeconomic environment start to look more benign, there’s a good chance that we’ll see reversion to more modest valuations because of that.
However, timing the market is difficult. These are good firms and they’re as far away as it’s possible to be from the cyclical business pressures affecting many other companies on the stock market. An investment horizon measured in years could lead to a good outcome eventually regardless of any over-valuation creeping into things now.
Sell some and hold some?
If I’d been holding Unilever, National Grid and British American Tobacco for the last six or seven years I would take profits now while still allowing a smaller core holding to run. Yet some market commentators expect multinational shares and defensives to be surprisingly strong performers for the rest of 2016.
Whether to buy, sell or hold at any particular point is always a very personal decision. But owning shares in good quality defensive firms such as these three puts you one step ahead and makes the issue of timing less important — as long as your investment horizon stretches into years rather than just days, weeks or months.
Looking forward, City analysts expect Unilever to grow its earnings by 8% next year, British American Tobacco by 9% and National Grid’s earnings to be flat. These aren’t declines in earnings, so perhaps the best strategy is to hold on tight after all.
