With the future of the global economy and the FTSE 100 being relatively uncertain, many investors are considering the purchase of less risky, more stable companies. This idea is sound since it can reduce the volatility which seems likely to be a feature of the coming months, with defensive stocks likely to outperform a falling index due to the potential for a flight to safety among investors.
That’s a key reason why, in the last three months, National Grid’s (LSE: NG) share price has risen by 13% and easily beaten the performance of the wider index. Looking ahead, National Grid could be a stronger performer than the market currently believes, since the potential for a rapidly rising US interest rate seems to be rather low. This means that the cost of servicing the company’s huge debt pile may not rise as quickly as is currently being priced in, therefore offering the scope for an upward rerating to the company’s valuation.
On this front, National Grid appears to be priced very fairly. It has a price to earnings (P/E) ratio of only 15.4 which, for a company with the stability, resilience and consistency of National Grid appears to be relatively appealing. Furthermore, with National Grid yielding 4.7% from a dividend which has an outstanding track record of rises, it continues to be a top notch income play which appears to be a strong buy for the long term.
Similarly, United Utilities (LSE: UU) also appears to be a sound long term investment and, like National Grid, its shares have risen by 15% in the last three months. Although it has a lower yield than National Grid at 4%, it too has an impressive track record of dividend growth as evidenced by an annualised rise in shareholder payouts of 5% during the last five years.
Looking ahead, sentiment in United Utilities could be pegged back somewhat by the liberalisation of the water market which is due to take place in 2017. Although the company appears to be well-placed to take the changes in its stride, it nevertheless represents change and the potential for winners and losers.
However, where United Utilities could see its valuation move upwards is with regard to its bid potential. With the water services market having a history of M&A activity, United Utilities may be a potential bid target – especially if, as expected, interest rates rise slowly and infrastructure assets maintain their present appeal.
Of course, not all defensive stocks hold such great appeal. ABF (LSE: ABF) may be a high quality business, but its P/E ratio of 34.5 indicates that it is overpriced. That’s especially the case when the changes within the company of recent years are factored in. Although food is still an important part of the company’s sales, ABF is increasingly becoming a retailer via the rise of its Primark division. And, while it has upbeat growth prospects, the retail sector is not all that defensive, which could lead to an increasingly volatile top and bottom line for the wider business.
With ABF also paying out just 34% of its profit as a dividend and therefore yielding only 1%, it lacks income appeal, too. As such, for investors seeking defensive stocks, the likes of National Grid and United Utilities appear to be better buys. Similarly, there also appear to be better value cyclical stocks on offer at the present time.
