Getting Defensive

 | Mar 19, 2013 | 1:00 PM EDT  | Comments
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Stock quotes in this article:

rs

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musa

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adm

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apa

Today I want to finish up a look at defensive stocks as defined by Ben Graham and slightly tweaked by yours truly. We are basically looking for non-financial companies with a long history of profits and dividends to buy on weakness and hold for an extended period of time. On Monday, I mistakenly reported that the screen only found four stocks that qualified. The good news is that the screen was set incorrectly and need a tweaking -- when corrected, the total number of qualifying stocks rose to by 25%. The bad news is that only five stocks still made the grade for a defensive portfolio.

Reliance Steel and Aluminum (RS) shares have pretty much tracked the market over the past few years, but the stock is cheap and will see strong growth as the economy continues to attempt a full-fledged recovery. The company provides metal processing services and distributes steel, aluminum, brass, copper and specialty metal products across a wide range of industries. They have historically grown by acquisition and this year will be no different as the company recently announced the purchase of Florida-based Metals USA Holdings (MUSA).

The company guided first-quarter earnings to much lower levels but indications for the rest of the year are quite positive as orders from the aerospace and energy industries have been firming up. The company also believes that nonresidential construction will improve in the second half of the year and spark increased metals demand. The company has remained profitable and paid a dividend through the economically difficult period. The shares are fairly cheap, as the stock currently trades at 12x earnings and 1.4x book value. The yield is just 1.7% bit the dividend has grown by 15% annually on average for the past decade and it should continue to do so.

I have previously mentioned Archer Daniels Midland (ADM) as an excellent defensive stock, but so far, it has not returned my affection. The shares are still well below the 2008 highs in spite of the company's dominance of the U.S. grain industry. The company processes, transports, stores and sells oilseeds, corn and related products. Weaker ethanol demand has hurt the company in the short term but, in the long run, increased global demand of protein meal and vegetable based oils should help boost earnings and the stock price to much higher levels.

The stock is cheap at current levels, trading at a slight premium to book value and just 12x earnings. Management recently increased the dividend and the shares yield 2.3% at the current quote. The company has remained profitable and has not only paid but also continually increased its dividend over the past decade. At some point, I believe that the continued creation of a global middle class will turn this into a great growth stock once again as demand for higher quality grain and food products swell. I just do not have a clue as to exactly when that might happen.

Our final defensive stock selection is another previously mentioned name. Apache (APA) has seen its share price decline as weaker natural gas prices and its large exposure to the politically uncertain Egyptian oil and gas markets have weighed on the share price. This is the first time in more than a decade that shares of the oil-and-gas producer have traded below book value; investors have dumped the shares in favor of more attractive names in more popular sectors.

Investors and traders may be far too negative on the shares. Apache is one of the world's largest independent oil-and-gas producers and it has negotiated troubled markets in the past. The company is increasing U.S. onshore oil volumes and has accelerated oil drilling activities in the North Sea. The company has been buying assets in regions it considers attractive from a long-term perspective. This should drive continued earnings growth for Apache. The company has grown profits and dividends at a respectable rate for the past decade and should do so over the next as well. At this price the bad news is baked in and there appears to be large upside for patient investors.

The number of defensive non-financial stocks has been thinning as the market moves higher but there is still a small pool of solid candidates. Remember, to make the market to work for you and not against you, it's best to buy down markets and scale into even the most defensive of stocks.

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