Uncertainty is rampant.
While Wall Street is reeling from subprime bailouts and buyouts, the S&P 500 index is about where it was 10 years ago. The same index is down double digits for the year and more than 20% from its October highs. That drop means it's a bear market.
Is it time to buy? After the last bear market, the S&P went on to almost double in value in the five years between October 2002 and October 2007.
Nobody knows how far and for how much longer the market will fall. Meanwhile, safe money alternatives such as CDs don't pay enough to send our kids to college or for us to retire at a reasonable age. So, what’s the next move?
How about defense?
Historically, defensive companies have tended to perform better in a down market because they provide life’s necessities and earn relatively stable returns in both good and bad economies. These companies can not only limit downside risk but also enable us to enter the market cheaply and position ourselves to participate in an eventual market upswing.
A great place to screen for stocks with defensive characteristics is Motley Fool CAPS. We'll start off by looking for stocks that have been rated four and five stars (the maximum number) by the 115,000-member plus CAPS community since these have significantly outperformed the market.
Then we'll add:
- Market cap of at least $5 billion
- Maximum beta of 0.5
- Average EPS growth of at least 20% over past three years
- Return on equity over 20%
Here are a few of the companies I found when I ran this screen:
|
Company |
CAPS rating |
Market cap (in billions) |
Beta |
EPS growth |
Return on equity |
Sector |
|---|---|---|---|---|---|---|
|
Eli Lilly (NYSE:LLY) |
**** |
$52.2 |
0.39 |
28.6% |
25.8% |
Health care |
|
Genetech (NYSE:DNA) |
**** |
$97.4 |
(0.77) |
37.2% |
23.2% |
Health care |
|
PPL (NYSE:PPL) |
**** |
$13.8 |
0.35 |
22.5% |
23.3% |
Utilities |
|
XTO Energy (NYSE:XTO) |
***** |
$28.8 |
0.29 |
27.0% |
21.4% |
Energy |
|
Alcon (NYSE:ACL) |
**** |
$50.6 |
0.23 |
22.2% |
42.5% |
Health care |
Source: Motley Fool CAPS, as of Sept. 23.
I'm not putting forth these stocks as recommendations, but rather as possible starting points for further research. But to get started, here are some thoughts on a stock in each of the different industries represented above.
Cheap but risky
While pharmaceuticals have often been called defensive, Eli Lilly is near its 52-week low and paying a 4% dividend. Lilly, like most big pharmaceutical companies, has not fared well since the 2000 highs. After reaching more than $100 in the summer of 2000, the stock is trading at just about $46 today.
Even though the stock may be cheap, JPMorgan downgraded it recently on the basis that Lilly does not have a sufficient pipeline of new drugs to make up for the loss of revenue resulting from key drugs coming off patent protection. On Sept. 26, the FDA will announce whether it will approve Lilly’s new blood-thinning drug, Prasugrel. The announcement is expected to have a significant affect on Lilly's share price, one way or another.
PPL looks to the future
This Pennsylvania-based utility pays a solid 3.6% dividend and sells near its 52-week low. Although utility earnings have historically been steady during tough economic times, the high price of fuel has put a dent in recent earnings. Some utilities have had difficulty passing short-term spikes in energy costs on to their customers.
PPL has fixed-rate contracts that, with last quarter’s spike in energy prices, have resulted in customers paying well below current market prices. A main catalyst for higher future earnings is that these contracts expire in 2010, and PPL plans a 34% rate hike. Possible lower energy costs and higher rates should boost profitability in the future.
XTO
This oil and gas company has fallen along with the plummeting price of oil all the way from its highs of more than $73 in July to just over $51 today. Competitors Apache (NYSE:APA) and Chesapeake Energy (NYSE:CHK) have also fallen hard since July. This seems to be a good play if you think the oil sell-off is overblown. Rising oil prices could bring the stock price back up in a hurry. Also, natural gas could be part of the energy solution that some, including T. Boone Pickens, are recommending. Increased demand for natural gas should bode well for this stock in the long term. For now, this is a volatile stock in a volatile industry that is currently experiencing the downside of that volatility, selling off nearly 40% in just the last two months before recently recovering slightly.
Final thoughts
Although it may not be as exciting, investing wisely during down markets can be even more important, in terms of long-term results, as investing wisely during up markets. To use an old football adage, offense sells tickets, but defense wins games.
