Defensive stocks are supposed to protect you from economic adversity. Groceries, booze, smokes, electricity, pharmaceuticals and other essentials-we may consume less of them in tough times, but not much less. Demand for these items isn't as cyclical as it is for cars or luxury watches.
Yet many of the defensive stalwarts that investors often turn to during financial crises weren't very solid at all during the crash of 2008 and its aftermath. Take Loblaw: In the early summer of 2008, as the North American economy started to wobble, the grocer's stock was trading at about $34 a share. When stock markets plunged in October of that year, the share price dived to $26. Since then, Loblaw has see-sawed up and down, and it's still hovering around $37.
Shoppers Drug Mart hasn't fared much better. The drugstore chain reached $55 a share in early 2008. Recently, the share price has been about $45. Empire Co., which owns the Sobeys supermarket chain, skidded from about $55 in 2008 to below $40 last year, and recently had yet to climb back to $50. The experience has been similar for Corby Distilleries, the Hershey Co., cigarette producer Altria (formerly Philip Morris), drug maker Pfizer, power generator TransAlta Corp. and many others. Have old-school defensive stocks seen their day?
Actually, I'd say the answer is no. What happened to these stocks during and after 2008 is a rare anomaly. If you examine their financials and their share prices now, some of them look like bargains. For the most part, their revenues and earnings have held up during the recession. So why has their share price performance been so lacklustre?
To answer that, we have to consider another trait many defensive stocks share: They tend to produce a lot of steady cash flow, and to pay out much of that cash in dividends.
Now recall that what led, in part, to the financial crisis and the recession was cheap and abundant debt in the early 2000s. Not just mortgage debt, but all sorts of debt. Investors were hungry for income, and they could borrow cheaply to buy solid, dividend-paying stocks. There was a tide of leveraged buyouts, and acquirers hoped to boost cash flow at the companies they bought and then use that cash to pay off their debts quickly.
The takeover fever inflated share prices. TransAlta, for example, was a frequently rumoured candidate. Because it and other defensive stocks were valued so richly before the 2008 market crash, they slumped during the recession. Investors who held them, or bought them just before the market plunge, were disappointed.
Could those investors have seen it coming? Yes. When a mature company's dividend yield is historically low, there's a very good chance its share price is too high. TransAlta's dividend yield when its stock price peaked at more than $35 a share in mid-2008 was 2.8%. Lately, with the price languishing below $25, the dividend yield has been about 5%.
Some of these stocks are looking very comfortably defensive indeed these days.