GlaxoSmithKline plc And Diageo plc, A Match Made In Heaven?

The market action of the past few months has shown investors how important it is to have a defensive element to every portfolio.

Diageo (LSE: DGE) and GlaxoSmithKline (LSE: GSK) are two of the FTSE 100’s most defensive companies. Their performance since the end of last year exemplifies why every investor should allocate a portion of their portfolio to defensive equities.

Indeed, year-to-date Diageo’s shares have returned -0.3% and Glaxo’s shares have returned +0.3%. On the other hand, the FTSE 100 has lost 3.7%. All of these figures are excluding dividends.

The difference in performance is even more noticeable over a six-month period. Specifically, since the end of August last year Diageo’s shares have returned 9.8%, and Glaxo’s shares have returned 4%. Over the same period, the FTSE 100 has lost 2.9%. Once again, all of these figures exclude dividends.

Should continue to outperform

Past performance should never be taken as a guide to future returns. However, there’s plenty of evidence that suggests Glaxo and Diageo’s outperformance will continue for the foreseeable future.

The reason this is likely to be the case is that both of these companies produce and sell highly defensive products, for which consumers are willing to pay a premium even during times of economic stress.

Diageo produces some of the world’s best-known alcoholic beverage brands, including Smirnoff vodka, Johnnie Walker whisky and Guinness. These premium brands command a premium price. For the past 10 years, Diageo has been able to achieve a net profit margin of around 20% per annum and a return on equity of 30%-plus. And unless the entire world suddenly stops drinking spirits overnight, Diageo’s sales are unlikely to collapse any time soon, implying that the company will continue to achieve impressive returns for investors for the foreseeable future.

Similarly, Glaxo also manufactures a range of products that are unlikely to go out of fashion any time soon. The company’s consumer health division produces necessities such as toothpaste and painkillers — two products that aren’t subject to cyclical trends. What’s more, the group’s vaccines and pharmaceutical divisions continue to see growth, if you exclude the sales of key products that are losing patent protection.

A strong portfolio

With their defensive product portfolios, Glaxo and Diageo should be able to continue to produce returns for shareholders going forward and combining the two in a portfolio could be a great low-cost, and low-effort, way to generate returns. £1,000 invested equally in each company would create a diversified portfolio with a yield of 4.4%.

Over the past five years, such a portfolio would have produced capital growth of approximately 8.3% per annum outperforming the FTSE 100 by a wide margin. If you include dividends, a portfolio of Glaxo and Diageo equally weighted would have produced a total return of more than 10% per annum.

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Rupert Hargreaves owns shares of GlaxoSmithKline. The Motley Fool UK has recommended Diageo and GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.