Ask Colin

In your talk the other night, you said that it is now time to buy more defensive stocks because they are likely to fall less in a bear market. I can’t find a reference to defensive stocks in your books or elsewhere. What do you mean?

Defensive in investing is a rather general term. It means roughly the opposite to aggressive or speculative. My main book is called The Aggressive Investor (out of print now, but updated as Building Wealth in the Stock Market) because my approach is aggressive in important respects around timing the market, active management and a focus on mid-cap and small-cap companies that are more risky than slower-moving blue chip companies. For this reason, my investment plan needs to balance its basically aggressive posture with some elements that are more defensive in nature. This has to do with the stocks I select to buy.

In The Aggressive Investor, I describe in detail how I go about selecting stocks. The very basics of this I covered the other night when I said it was a time to be more defensive. I suggested that it was the market season in which we should avoid speculative stocks and those laden with debt. Instead I suggested that we should focus on well-managed companies that were still good value. This is what I mean by defensive, in that these companies should generally be less vulnerable to price declines in a bear market.

In The Aggressive Investor and again in Hot Stocks (out of print now), I explain my two models for stock selection – value model stocks and growth model stocks. In both cases I am looking for relatively low PE ratios and relatively high dividend yields. In the case of value model stocks, this means a PE ratio that is significantly lower than the market average and a dividend yield which is significantly higher than the market average. It is not easy to do the same with growth stocks, but I am defensive in that I seek PE ratios that are not too far above the market average and dividend yields that are not too much lower than the market average.

Once I find these companies, the job is not complete. I then have a short list for further research and a final decision. In looking for defensive situations I will generally try to avoid cyclical industries like construction and banking. If possible I want the portfolio to be strongly focussed on companies that are in non-cyclical industries and are relatively cheap in value terms.

 

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