Defense! Defense!

After a big recovery in the stock market and with experts providing conflicting opinions about the market's next move, investors may be looking for ways to stay in the market, but get some protection against a downturn. One answer: Add some defensive stocks.  

Defensive stocks are typically established, dividend-paying companies with products that are always in demand. Think food, beverages, utilities, health care, etc. These stocks won't protect against a loss, but they tend to hold up better than the overall market in a downturn.

But which stocks? I ran the Motley Fool CAPS screener to help find stocks that fit a defensive profile. Search parameters were:

  • Market capitalization greater than $1 billion (established companies).
  • CAPS rating of four or five stars (out of five).
  • Price-to-earnings ratio less than 18 (earnings to cover a dividend).
  • Long-term debt-to-equity ratio less than 1.0 (manageable debt levels to deal with trouble).
  • Current ratio greater than 1.0 (cash on hand to cover near-term expenses).
  • Current dividend yield of 2.75%-5% (a reasonable dividend provides price support while a high dividend can be unsustainable or a sign of trouble).
  • Last three years' earnings-per-share (EPS) growth rate greater than zero (stocks that can grow earnings in a weak economy).

The screen returned 30 stocks. Companies in businesses sensitive to the economy were then sifted out. Results included the stocks shown in the table below. In addition to some of the screening parameter results, I calculated each stock's performance during the Oct. 9, 2007-to-March 9, 2009 bear run, along with the S&P 500 performance over the same time frame. Although none of the stocks generated a positive return over that time frame, even the worst performer in the group beat the benchmark by more than 15 points.

Company Name

Sector

Current Dividend Yield %

EPS Growth
Past 3 Years

Price-to-Earnings (TTM)

Bear Market Profit / (Loss)

ConAgra Foods
(NYSE: CAG  )

Consumer Goods

3.5

20.87

13.4

(39.5%)

Flowers Foods
(NYSE: FLO  )

Consumer Goods

2.9

16.7

17.3

(0.4%)

General Mills
(NYSE: GIS  )

Consumer Goods

2.7

10.86

14.7

(11.9%)

Kimberly-Clark
(NYSE: KMB  )

Consumer Goods

4.0

10.32

13.4

(34.3%)

Abbott Labs
(NYSE: ABT  )

Health Care

3.0

36.96

14.9

(11.6%)

Johnson & Johnson
(NYSE: JNJ  )

Health Care

3.1

7.77

13.8

(26.6%)

Exelon Corp.

Utilities

4.6

18.33

11.3

(41.4%)

WGL Holdings

Utilities

4.6

9.74

13.5

(10.8%)

S&P 500 Index

-

-

-

-

(56.8%)

Source: Motley Fool stock screener as of Jan. 26, 2010.
TTM = trailing 12 months.
Bear market loss data based on historical closing stock prices adjusted for dividends on Oct. 9, 2007, and March 9, 2009, from Yahoo! Finance.

Investment decisions should never be made solely on results from a screener. Screen output is just a starting point for further research.

It's also a good idea to play with the screen parameters to see if some good stocks might be just outside the range. For example, blue chip Procter & Gamble (NYSE: PG  ) just missed the current ratio cut for this screen, but would certainly qualify as a defensive candidate.

A little defense is just the ticket for investors worried about the possibility of a market drop or rich valuations, but who still want to be in the market.

What do you think? Is it time to beef up the defense?

More defensive Foolishness:

Fool contributor Russ Krull owns shares of Johnson & Johnson, but no other stock mentioned in this article. Johnson & Johnson, Kimberly-Clark, and Procter & Gamble are Motley Fool Income Investor recommendations. The Fool owns shares of Procter & Gamble. The Fool has a disclosure policy that protects us in bull and bear markets.


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