When Neil Woodford started his own fund management business he began by launching the CF Woodford Equity Income Fund with the aim of investing in quality companies with sustainable dividend growth.
The firm’s website tells us that Woodford expects to achieve capital growth and a growing income stream for investors by investing over the long term.
Getting the big calls largely right
Mr Woodford has earned a reputation for getting the big calls largely correct and thus doing a lot to protect his fund investors’ capital, such as avoiding the big banks before the financial crisis and keeping away from them ever since. He also turned his back on those traditional high dividend payers the utility firms when he thought regulatory risk was too high.
Since the Equity Income fund’s launch in June 2014, the total return stands at just over 31%, which continues a decades-long run of success for Mr Woodford. Given his impressive long-term investment record, I reckon it’s a good idea to consider the shares he seems most keen about, and by weighting, number one and number three in the CF Woodford Equity Income Fund are pharmaceuticals giant AstraZeneca (LSE: AZN) and tobacco products firm Imperial Brands (LSE: IMB).
Despite many other FTSE 100 firms getting the chop from the fund recently, these two account for more than 16% of funds invested. I think it could be safe to assume he really likes them (still). So why might that be?
Defensive characteristics
The Woodford website says that: “Investors expect a positive return and that is what we aim to deliver over the long term – protecting capital is key.” This emphasis on avoiding losses as a key step to realising gains chimes with the advice we receive from other well-known investors such as Warren Buffett and Peter Lynch.
AstraZeneca and Imperial Brands strike me as good vehicles to help investors avoid losses because of their defensive characteristics. Both firms deal in short-life consumable goods that people buy over and over again. Medicines and tobacco products are among the most ‘sticky’ of all such consumables, people rarely forgo them no matter how tough economic times become.
That’s the essence of defensiveness because it leads to reliable cash inflow for a firm, which enables a strong dividend. From such a base, any growth at all is the icing on the cake.
Valuation
It’s one thing finding a firm with a defensive business, but such attractive qualities often come at a price, expressed in a high valuation.
Yet at 4,605p, AstraZeneca’s forward price-to-earnings (P/E) ratio runs around 14.5 for 2018 and the forward dividend yield is just under 4.9%. Meanwhile, at 3,762p, Imperial Brands’ forward P/E for the year to September 2018 is just over 13 and the forward dividend yield is running just above 5%.
These are not wild over-valuations, in fact, they look modest and must add to the attraction that Neil Woodford sees. I reckon these two evergreen defensive stalwarts are a good place to start if you are building your own defensive portfolio and I would buy them right now.
