Global economic turmoil along with two years of strong stock market performance are starting to put investors on edge. Factor in today's surging commodity prices and it's no wonder the markets have been volatile. Yet all of this is occurring despite the fact that, for the most part, U.S. corporate earnings continue to show signs of growth. So what should investors trust - the technical movements of the markets, or the increasingly sound fundamentals of many U.S. companies. (For background reading, see Guard Your Portfolio With Defensive Stocks.)
TUTORIAL: Stock Basics
A Great Offense ...
One of the defining characteristics of the two-year stock market rally in the U.S. has been an unbelievable surge in smaller cap discretionary type businesses. For example, retailer Bon-Ton Stores (Nasdaq:BONT) was trading as low as $1 during the recession and now trades for $10. This is despite the fact the retailer continues to report losses and sits on nearly $1 billion in net debt against tangible equity of $53 million. Or consider Dollar Thrifty Automotive (NYSE:DTG), which was trading for less than $5 in early 2009. Today, the rental car chain trades for $80 and is currently the target of an unsolicited buyout offer from rival Hertz (NYSE:HTZ) for $72 a share. (For more, see Hertz Back In The Driver's Seat.)
Indeed, the past two years have been very rewarding for the aggressive investor. However, with markets at current levels and equity prices where they are today, the risk assumed in investing is elevated. Fortunately, the market has been so enamored with small caps and other lower quality issues, that defensive stocks still look very attractive.
... Needs a Strong Defense
While I can't predict markets, it's safe to say that the days of easy investment multi-bagger returns are gone for now in the U.S. However, large, high-quality defensive names look as appealing as they have during any bull market. Pharmaceutical giant Abbot Labs (NYSE:ABT) currently yields 3.6% and trades at a forward P/E multiple of 11 times earnings. The defensive nature of this company's business offers quality protection to investors today and a decent upside scenario over the next couple of years. Tech giant Cisco (Nasdaq:CSCO) currently trades for $16.50, or a market cap of $90 billion. The company has more than $5 per share in net cash and averages more than $10 billion in free cash flow per year.
The Bottom Line
Attention to risk is paramount in investing wisely and successfully. From the standpoint of valuation and cash flow generation, large defensive type stocks pose minimal risk for upside potential.
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