Ask Colin

In your article Trend Trader in Shares, July 2001, you mentioned in one of your points in your stance in the Australian market that you "focus this exposure on defensive situations. Defensive means they have lower than average p/e ratios and higher than average dividend yields." Is the comparison with the overall market, within the sector or historically for the stock itself, or a combination of all 3 with equal or different weights of importance ?

In your article Trend Trader in Shares, July 2001, you mentioned in one of your points in your stance in the Australian market that you "focus this exposure on defensive situations. Defensive means they have lower than average p/e ratios and higher than average dividend yields." Is the comparison with the overall market, within the sector or historically for the stock itself, or a combination of all 3 with equal or different weights of importance?

I start off with a very coarse filter of PE ratio of 10 times or less and Dividend Yield of 5% or more. The resulting list gives me a starting point. Shares that fall in this range are my preferred targets. However, I am then prepared to move a little outside it depending on the circumstances.

One circumstance will be financial risk. For example, a bank or a finance company, which by nature are highly geared, generally trade at lower PE ratios and higher dividend yields than industrial stocks to reflect the greater risk. Many people have taken advantage of this in the 1990s when the conditions for banks have been good and the market has re-rated them to higher than normal PEs. The trick is not to be caught with them when things return to the historical norms.

Highly cyclical companies that are also traditionally highly geared like property developers are also generally given a lower PE by the market because of the higher risk.

Companies with good long term growth rates are generally given higher PEs by the market.

I will take these sectoral and individual company norms into account also, but it is not a precise science. It is essentially a judgement. The risk is that we get caught up in the excitement and hype that goes on around good companies. For me to regard a company with a PE over 20 as defensive, would need for it to be the greatest company of all time. I will buy such a company as a short term trade when I think the market is re-rating it. However, not when market risk is high, like it is now (mid 2001) and my strategy calls for defensive stocks. I am looking for stocks in an uptrend with PEs below 10 and not in risky industries.

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