Every portfolio should include some defensive stocks. Such stocks protect investors from the madness of the market as they usually bring calm to periods of turbulence.
However, choosing which are the best defensives for your portfolio can be tough. Do you go for the cheapest stocks or those with the highest profiles?
GlaxoSmithKline (LSE: GSK) and Reckitt Benckiser (LSE: RB) are two of the most defensive equities in the FTSE 100, but both have very different qualities. Glaxo is one of the world’s largest pharmaceutical companies. As long as humans exist the company’s products will be in demand so even during times of economic stress, Glaxo’s sales continue to chug along.
Reckitt is also active in the pharmaceutical market although the company’s pharma operations are more customer-focused with over the counter treatments making up the bulk of its sales in this area. The company’s main line of business is the production of consumer goods, washing powders, detergents, and condoms. All of these are relatively essential products and demand will remain high even during economic downturns.
Steady long-term growth
Reckitt’s defensive product line has helped the company grow rapidly over the past decade. At the end of 2006, Reckitt reported sales and net income for the year of £4.9bn and £670m respectively. At the end of this year, City analysts have pencilled-in sales of £9.8bn and a pre-tax profit of £2.6bn. Next year analysts are expecting the company to report revenues of £10.6bn and a pre-tax profit of just under £3bn.
The problem with Reckitt is that if anything, the company has been too successful. Its shares currently trade at a forward P/E of 24.8, a premium valuation that doesn’t leave much room for error. Indeed, this multiple implies that investors believe the company’s rapid growth will continue indefinitely. Unfortunately, if Reckitt’s growth engine splutters, the shares could quickly re-rate.
Glaxo’s shares are more appropriately priced in comparison. The shares currently trade at a forward P/E of 17.5 and support a dividend yield of 4.8% compared to Reckitt’s minuscule yield of 2.2%.
Still, there’s a reason why Glaxo’s shares are cheaper than Reckitt’s, and that’s growth. Specifically, at the end of 2006 Glaxo reported sales of £23.2bn and City analysts are expecting the company to report sales of £27bn for 2016. So the company is growing at a fraction of the rate of Reckitt.
Roaring back to life
Glaxo’s growth has stagnated as the company grapples with the loss of exclusive manufacturing rights for some its key products. The past few years have been touch and go for the firm but management now seems to have steadied the ship. City analysts are forecasting earnings per share growth of 27% this year and 7% for 2017, reversing several years of falling earnings.
And considering the above growth forecasts, coupled with Glaxo’s low valuation it looks to me as if it could be a better defensive bet than Reckitt.