Stocks for those who fear heights

If the market's strong first quarter has you worried that investors are too bullish, try switching to defensive plays.

By John Reese Apr 2, 2012 1:59PM

Image: Bull (© Photographers Choice RF/SuperStock)Ever since the 2008 market collapse and financial crisis, many investors have been suffering from a fear of heights.


Whenever the market goes on a nice upward run, they get fearful -- very fearful -- with the still-fresh scars of the '08 crash leading them to think that what goes up will certainly come down. That's what seems to be happening right now. With the market having a very strong first quarter, fears have arisen that things are too good, and sentiment is overly bullish.


I for one don't think it has. Valuations remain reasonable, and the gains in the market have been accompanied by some very real, significant improvements in the economy. New claims for unemployment have continued to fall lower and lower over the past three months, as have continuing claims. The manufacturing and service sectors have both continued to expand during the quarter, retail sales continue to grow, and the S&P 500 still trades for about 14.6 times trailing 12-month operating earnings and 16.2 times trailing 12-month as-reported earnings.


Still, given the market's rise and the lingering scars of 2008, it's tempting at times like these to take the profits and bail on stocks. But keep in mind that trying to time the market is a dangerous game, and numerous studies show that most investors fail when they try to do it. If you really need to calm your nerves, however, I think a better option than bailing on the market altogether is to simply switch to some more defensive areas. That way you give yourself some downside protection, but you also stay exposed to stocks and can capture a good amount of the market's gains if stocks continue to flourish.

 

With that in mind, I recently used my Guru Strategies -- each of which is based on the approach of a different investing great -- to look for some fundamentally strong stocks in more defensive sectors of the market. I found a number of intriguing plays; below are some the best of the bunch. These are the sort of stocks that should allow you to stay in the market, without staying up all night worrying about your portfolio.


Xcel Energy Inc. (XEL): Utilities are traditionally a very defensive sector, and my James O'Shaughnessy-inspired growth model is finding a lot to like about this Minnesota electric and natural gas utility, which has operations in eight Western and Midwestern states. The O'Shaughnessy growth approach looks for companies that have upped earnings per share in each year of the past half-decade, which Xcel ($13 billion market cap) has done, and which have a key combination of variables: a high 12-month relative strength, which is a sign that the market is embracing the stock, and a low price-to-sales ratio, which is a sign it hasn't gotten too pricey. Xcel has a very reasonable 1.2 price-to-sales ratio, and a solid relative strength of 74, so it makes the grade.

 

Molson Coors Brewing Company (TAP): This Denver brewer makes some of the world's most popular beers, including Coors Light, Heineken, Amstel, Molson, and Carling. The $8.1-billion-market-cap firm is a favorite of my Peter Lynch-inspired strategy, which considers it a "stalwart" -- the type of big, steady company Lynch found offered protection in tough times. (And, let's face it, when times get tough, people still find a way to buy beer.)

 

Lynch famously used the price/earnings-to-growth (PEG) ratio to find growth stocks selling on the cheap, and for stalwarts he added dividend yield to the growth portion of the equation. When we divide Molson's 12.4 price-to-earnings ratio by the sum of its 12.3% long-term growth rate (I use an average of the three-, four-, and five-year earnings per share (EPS) growth rates to determine a long-term rate) and dividend yield (2.8%), we get a yield-adjusted PEG of 0.82. That comes in comfortably below this model's 1.0 upper limit, sign that it's a bargain.

 

Advance Auto Parts, Inc. (AAP): An auto parts business like Virginia's Advance ($6.4 billion market cap) can help you play defense because when times get tough, people are more likely to fix up their existing cars than buy new ones. And Advance did well during the Great Recession, upping EPS in both 2008 and 2009 -- in fact, it has increased earnings in every year of the past decade. It's a favorite of my Lynch-based model, which likes the firm's 22.6% long-term growth rate and 0.76 PEG ratio. My O'Shaughnessy growth model also likes Advance's history of persistent earnings growth, as well as its combination of a 1.04 price-to-sales ratio and 90 relative strength. 

 

The TJX Companies (TJX): The parent of discount retailers T.J. Maxx and Marshalls, the Massachusetts retailer ($30 billion market cap) fared very well during the Great Recession as consumers flocked toward bargains. It's continued to do well during the recovery, and has upped EPS in each year of the past decade, part of the reason my Warren Buffett-based model is high on it. A couple more reasons: The firm has enough annual earnings that it could, if need be, pay off all its debts in less than a year, and it has averaged a 37.7% return on equity over the past decade.

 

TJX also gets strong interest from my Lynch-based model, which likes its 21.5% long-term growth rate and 0.94 PEG, and my O'Shaughnessy-based growth approach, which likes the stock's combination of a 1.28 price-to-sales ratio and 94 relative strength.

 

Johnson & Johnson (JNJ): The diversified healthcare giant had a rough fourth quarter, barely eking out a profit amid the fallout from several product recalls. But it still upped revenues for the period -- and it has a lengthy history of success and still boasts a number of strong brand names. Healthcare firms often provide defensive protection to a portfolio, and my O'Shaughnessy-based value model thinks JNJ is a good bet. It looks for large firms with strong cash flows and solid dividend yields, and JNJ fits the bill. It has a $180 billion market cap and more than $65 billion in trailing 12-month sales; $4.66 in cash flow per share, more than three times the market average; and a solid 3.5% dividend yield.

 

I'm long TJX and AAP.


John Reese is founder and CEO of Validea Capital Management and Validea.com, a premium investment research site, and author of The Guru Investor: How to Beat the Market Using History's Best Investment Strategies.


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