3 Defensive Stocks That Could Prove To Be Winners

With the S&P 500 still close to all-time highs, now could be an opportune moment to consider more defensive alternatives. Here are 3 tobacco plays that could fit the bill.

Apr 16, 2014 at 1:38PM

There are certain investment-related quotes that appear when markets are at extreme levels. For instance, the classic "buy when blood is running in the streets" (Rockefeller) is a useful reminder that a vast proportion of profit is made when shares are bought (at a very low price) rather than when they are sold. Similarly, Warren Buffett's quote "you only find out who's swimming naked when the tide goes out" is a useful reminder that taking high levels of risk at the wrong time can be very costly.

So, with the S&P 500 still within touching distance of its all-time highs and the Federal Reserve beginning the tapering of its monthly asset repurchase program, could now be a good time take some risk off the table and instead reallocate capital to lower beta, higher yielding, defensive plays?

Tobacco Stocks Could Add Value
Tobacco stocks benefit from fairly stable demand for their products. Whether the US and global economy is in a boom or a recession, people still smoke, with a switch to a lower/higher price point brand (depending on the state of the economy) more likely than giving up the habit as a result of less disposable income. Due to this, tobacco companies tend to offer lower betas and a more secure dividend payment than many of their index peers. Both of these attributes could prove vital during a market correction or bear market.

Here are three tobacco stocks that could fit the bill in terms of betas, yields and defensive attributes.

Put simply, Altria (NYSE:MO) provides superb defensive qualities. For instance, its beta is currently just 0.4, which means that a 10% decline in the index level should equate to a decrease of just 4% in Altria's stock, with the same being true of gains, should the market continue to make higher highs. This low beta means that Altria could reduce portfolio volatility going forward.

Meanwhile, Altria's yield of 4.9% is vastly higher than that of the index (the S&P 500's yield is just 2%), and this could prove useful in times of market corrections when 'cash is king.' In other words, it could provide a stable income with which to invest when index levels are low. In turn, this could provide higher profits in the long run, as shares in quality companies can be purchased at distressed prices (when blood is running in the streets).

Philip Morris
The 4.4% yield offered by Philip Morris (NYSE:PM) is well-covered at 1.5x, which seems to be very sensible and shows that the company is not over-extending itself when it comes to payments to shareholders. This makes the income from the stock even more sustainable and highlights its potential as a sound defensive play.

The price for a great yield and defensive business model, though, is not excessive. With the S&P 500 trading at a forward price to earnings (P/E) ratio of 15.4, Philip Morris appears to offer good value for money at current levels, since its forward P/E is 15. Although higher than Altria's forward P/E of 13.9, it is still relatively good value when compared to the index and shows that there are still potential buying opportunities in this market.

When it comes to low betas, Reynolds (NYSE:RAI) is the clear leader of the three stocks. Its beta is just 0.3, which means that it could offer a lower volatility of returns than many of its index peers and could outperform the wider index during a market correction. Furthermore, Reynolds' yield of 4.7% compares well with its two tobacco peers and provides investors with an income at a time when the interest rates on savings accounts are extremely low.

As for its P/E, although it's higher than Altria's, Reynolds' forward P/E of 14.9 is less than that of Philip Morris. It is also less than the S&P 500's and shows that all three stocks offer good relative value when compared to the index.

In addition, Reynolds' payout ratio of 79% is not particularly excessive for a company that has operated in a mature industry for a long time and appears to strike a balance between reinvestment within the company and the provision of an income for shareholders. In fact, the dividends for all three companies appears to be sustainable, which only adds to their attraction as defensive plays.

The Future Is Unknown
Of course, the S&P 500 may make fresh highs and not take back the gains it has made since the Federal Reserve's monthly asset repurchase program commenced. If, on the other hand, it does go through a tough period, Altria, Reynolds and Philip Morris could help you to overcome the lows and instead take advantage of a more attractive price level in the wider index so you're set up well for the eventual highs.

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Robert Stephens has no position in any stocks mentioned. The Motley Fool owns shares of Philip Morris International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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