In these economically turbulent times, the received wisdom is that equity investors have two key choices. One is to run as far away from the market as possible, liquidating their holdings and sticking the proceeds in cash or safe government bonds. The other option, for equity die-hards, is to re-weight their portfolios towards more defensive sectors that are less sensitive to economic ups and downs. Certainly, during the great sell-off in late 2008 and early 2009, sectors such as pharma and tobacco held up relatively well compared with the rest of the market and continued to pay out juicy dividends from their ever-robust cash flows.
But there is, to pinch a phrase from Tony Blair and New Labour, a "third way". That is to look for companies in otherwise cyclical industries that have hit upon businesses models which see them perform steadily through thick and thin. We've dubbed these companies 'the new defensives', but you may also have heard us previously describe them as offering 'defensive growth'.
In other words, these firms should continue to grow even if the economy takes another turn for the worse.
What makes a new defensive?
We've identified several attributes that may qualify a company as a new defensive, and although we don't expect our companies to meet all the criteria, they should be able to tick at least a few of the boxes.
It's a combination of these attributes that's important, as we're looking for companies that offer more than just pure growth or defensive credentials. So, for example, even though SuperGroup is a company with solid prospects, it doesn't make it into our group. That's because while it's currently outpacing the growth of the high street, clothing is still somewhat discretionary, clothing retail is extremely competitive, and young shoppers are notoriously fickle. Put simply, it lacks the defensive element we're looking for. Likewise, tobacco shares may offer security of dividend income, but volume growth is proving increasingly hard to come by for the industry.
One good example of a company that would have made our list were it not now in the middle of a takeover battle is British Sky Broadcasting. Somewhere along the line, the definition of the word 'necessity' widened to include satellite TV and Premiership football, helping the company sell its subscription TV service to nearly 10m UK households – there are few alternatives. The business has kept going even during bad years as consumers opt for a cheap night on the sofa rather than an expensive night out – fulfilling the cheap treat criteria. The subscription model is advantageous, as it means that, unlike ITV, it isn't exposed to the economically sensitive advertising market. And although it pays handsomely to secure the rights to leading sports content, that's paid back in droves, with each customer generating an average of around £500 a year.
