Recent turbulence in the markets is a reminder of the benefits of having a core holding of defensive shares. But dire interest rates and fear of a bond bear market have spurred investors to switch from cash and bonds into quality defensive shares, many of which pay handsome yields and offer bond-like security.
The result? Stocks like Unilever and Diageo are trading at historically high multiples, with prospective price-to-earnings (P/E) multiples of 19.7 and 19.4 respectively. It’s no cause to panic — both these stocks have great brands and diversified earnings. Investors may sacrifice potential upside if there’s a stock market rally but they’re getting good downside protection in return, while picking up a decent yield.
Cheapest
But for my money, GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) stands out as the cheapest of the quality defensive stocks. It’s on a prospective P/E of 15, not far above the market average, and yields 4.5%.
I’m not alone in being a fan of GSK. Deutsche Bank upgraded the shares to a ‘buy’ last month and said they should trade at 1,930p to be on a par with peers whose shares have recovered better since earnings were downgraded in the sector in 2011. That helped push GSK’s shares to an 11-year high, but at 1,742p today they’re still well below Deutsche’s target price.
Barclays upgraded GSK in January. The indication from both brokers is that the company has turned the corner on its patent cliff, the issue that has dogged pharmaceutical companies in recent years. The impact of drugs coming off patent has mostly run its course with GSK and new products are in the offing, including melanoma, HIV and lung disease therapies.
Diversification
What’s more, GSK successfully diversified away from a pure pharma business model some years ago. 30% of sales come from vaccines, which have a lower-risk profile, and consumer healthcare, with products such as Lucozade, Sensodyne and Panadol.
It has also pushed hard into emerging markets where growing and ageing middle classes are driving increased drugs sales, though recent developments in China highlight the dangers inherent in such countries. China’s anti-trust watchdog is expected to force down prices, while some GSK employees have been accused of ‘economic crimes’.
GSK has another fan, too. One of its biggest shareholders is Invesco Perpetual’s star fund manager Neil Woodford. Mr Woodford’s high income fund is “the best performing of any fund investing in the UK since it launched”, according to Hargreaves Lansdown. Nearly a quarter of his £22bn funds are invested in just three companies in the pharmaceutical sector, including GSK.
You can learn more about how Mr Woodford selects stocks, and the identity of his other pharmaceutical investments, in an exclusive report from the Motley Fool. You can download it by clicking here — it’s free.
> Tony owns shares in GSK, Unilever and Diageo but no other shares mentioned in this article. The Motley Fool has recommended shares in Unilever.