How to select your stocks if you are a defensive investor?
June 03, 2021 | Frazer pugh
Two types of investors are generally considered by beginners: active or passive investors. These two are somewhat similar to defensive and enterprising investors. If you want to take a more conservative approach to investing, becoming a defensive investor is a great alternative.
To select your stocks, here is a guide I have for you.
What are defensive investors?
Defense investors are investors who don’t want to spend time and money. These investors don’t want an aggressive investment strategy and a portfolio that requires little analysis and supervision. Hence, they seem to follow cautious investments as they may not need so much commitment.
Most financial analysts suggest that investors choose stocks based on their degree of risk exposure. However, these investors would also take risks based on their greedy smart efforts.
Passive or defensive investors would also expect their portfolios to achieve average returns. These buyers are able to build balanced investment portfolios and invest in stocks and debt. It also suggests that conservative investors should prefer to invest 50% in stocks and 50% in bonds or cash.
You will rebalance investments if the valuation is increased by 10% or more on each hand. So if the fund is made up of 60% stocks and 40% bonds, defensive investors will sell 10% of their equity and bond portfolios to reach their 50-50 balance.
How to choose your stocks if you are a defensive investor?
To make security selection easier, there are 7 security selection requirements for defensive investors. If you are a defensive investor, you will choose the best value for your portfolio using these parameters.
size of the company
Defensive buyers may rule out small company stocks as they could be subject to above normal volatility, assuming larger company earnings are more robust. In addition, consumer sentiment towards these companies is generally positive. However, some companies are unlikely to impress investors with their profit results. They are stable and do not normally perform poorly or excessively. If you take a look at a small business, on the other hand, profits will vary by quarter. Defensive investors need less risky securities. Large limits are also recommended.
Stable current ratio
Current ratios are a common indicator of a company’s short-term liquidity. This is measured in relation to the assets and liabilities allocated to the company. More simply, it measures the ability of the company to generate sufficient income to repay its obligations and is also used to assess the financial stability of the company.
To calculate a company’s current ratio, this formula is often used:
Current ratio = Current assets / Current liabilities
The current appropriate ratio varies by industry sector. While a 1.5 to 3 ratio is normally considered safe, before determining it you should make sure you look at the industry average. Be wary even of companies with an existing ratio less than 1, as this may indicate a company having liquidity difficulties.
A current ratio above 3, on the other hand, can mean that an organization is not managing operating resources and / or assets optimally. A high current ratio means that the risk of insolvency for defensive investors is lower.
A business must be able to generate good, stable income over time to be worth an investment. He advised defensive investors to look at income over the past ten years to determine if the business has become stable and consistent over time.
Capable of paying dividends
Defensive or cautious investors seem to favor dividend-paying stocks as they generally seek a consistent source of income. They should also consider a company’s dividend payment history before investing in the company. He advised defensive investors to look for companies with a long and stable history of dividend payments over the past 20 years.
With growth potential
Some experts doubt that anyone can reliably predict a company’s revenue growth. That is why they choose to invest in companies that are constantly increasing their income. It can show that the organization is improving. Defensive buyers should look for companies with average initial and final three-year income growth of 33% per share over the past 10 years.
Price / earnings ratios
Many buyers are looking for stocks with a low price-to-earnings ratio, which can’t be the only reason. Defensive investors can look for stocks whose current share price is no more than fifteen times the average income for the past three years. You should also be aware that P / E ratios vary by sector / industry. Therefore, be sure to look before making a judgment on the P / E ratios of the company’s competitors.
Price / asset ratio
The price / asset ratio is not as visible as it used to be. Although this is mainly due to the growth of technology firms, by studying the more capital intensive firms in conventional industries such as construction, consumer staples, petroleum and software, the price / asset ratios benefit defense investors.
Graham advises that the actual inventory price should not exceed 11.5 times the last published book value. However, if the company’s P / E ratio is less than 15, the price / asset ratio may be higher. It also offers:
Asset price Multiplier x Book value price
What are the rules for selecting your stocks?
The above criteria can surely help you become a more effective defensive investor. But, there are also rules for choosing your actions.
Equity portfolios have higher returns than long term loans, which protect the lender from inflation. However, these benefits can only be obtained if the shares are bought at the right price. This applies more to defense owners as they are not involved and instead rebalance their investments as big adjustments arise. There are four basic rules for defensive investors to invest in popular stocks.
Diversification is an inevitable function of the investment strategy for defensive buyers. Since protective investors are not aggressive investors, a diversified portfolio can also reduce the effect on their returns of unfavorable price movements. In its equity funds, defensive buyers can hold around 10 to 30 stocks.
Choose large companies and conservative companies
Defensive buyers should look for large, cautious stocks. Although the returns of these stocks are lower than those of small and medium-sized companies, they are more resilient and have predictable returns. This fits well with the profile of a defensive investor.
Check the clear history of dividend payments
Defensive investors can also look for companies with a consistent history of paying dividends to shareholders. You need to be sure about the last twenty years of the dividend payment trend.
Don’t buy at any price
It is essential that protective buyers ensure that the price of a stock is restrained. We recommend that in the past seven years, we spend no more than twenty times the average income and 20 times the income of the previous 12 months. Defensive investors would also keep growth stocks free because they are too expensive and dangerous.