It’s Time to Get Defensive

08/08/2007 12:00 am EST

Focus:

Sam Stovall

Chief Investment Strategist, CFRA Research

Sam Stovall, Standard & Poor’s chief investment strategist, says investors should look at large, defensive stocks that pay big dividends, and he finds two that really fit the bill.

[Since] the Dow Jones Industrial Average established a record high above the 14,000 level, US equity markets declined and the Standard & Poor’s 500 slumped [6.6% before bouncing back from last week’s lows].

At this point, S&P believes many investors are considering three options. The first is to raise cash. The second is to stick with stocks, but with an emphasis on defensive issues. The third choice is to be brave and buy beaten-down issues. S&P is going with the second option.

So, what are defensive issues? Two things stand out—beta, which measures an asset’s volatility vs. the S&P 500; and dividend yield, the amount one gets paid while waiting for share prices to recover.

Within the S&P 500, the consumer staples, health care, utilities, and energy sectors had the lowest betas (0.8 or less). The materials, telecom services, and technology groups were more volatile, registering betas of 1.2 to 1.6 (meaning that the sectors were that much more volatile than the overall market—Editor). Utilities, telecom, consumer staples and financials offered the highest yields.

We investigated further to find low-beta, high-yield companies ranked Buy or Strong Buy [in attractive industries] by S&P analysts. The search yielded five industries: tobacco, pharmaceuticals, brewers, soft drinks and water utilities. Two [of the stocks we found] carry strong Buy recommendations.

One of these is Bristol-Myers Squibb (NYSE: BMY). We expect the company’s revenues to advance 8% in 2007 on a 50% increase in sales of the blood-thinning agent Plavix. A recent court decision upheld the patent on this drug, which we think is a major victory [that] makes Bristol-Myers even more attractive as an acquisition candidate.

In our view, annual interest costs on a possible $80-billion takeout price ($40 a share) could be financed via free cash flow, the elimination of cash dividends, and reductions in [selling, general and administrative expenses, and research and development] spending. (The stock closed a bit under $29 Tuesday—Editor.)

The other five-STARS stock in the table is Altria Group (NYSE: MO). We see the company’s revenues benefiting from acquisitions in international tobacco and market-share gains for domestic tobacco. We expect sales volumes to grow, driven by brand investments, acquisitions, line extensions, and new-product introductions.

We foresee higher prices and improving volume trends supporting a 2% increase in Philip Morris USA’s revenues, and we look for Philip Morris International’s tobacco sales to increase 8% on acquisitions, currency benefits, and volume gains in most countries. (The stock closed slightly above $29 Tuesday—Editor.)

Since we think this recent market pullback will end up being a correction within a bull market and not the start of a new bear market, we suggest investors consider these low-beta buys while we await an expected turnaround.

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