Is your goal of stock investing to generate market-beating total returns or income? It’s achievable with a defensive stock portfolio. Here are a few tips you can consider for building such a portfolio.
Buy and hold large, quality stocks
Look for large-cap stocks with good balance sheets and leading positions in their industries. A large-cap stock has a market cap of $10 billion or greater.
Generally, large-cap, quality stocks are more defensive during market corrections. Moreover, on a market recovery, they tend to bounce back first as investors fly to quality in a stressful macro environment.
For example, Amazon (NASDAQ:AMZN) and Royal Bank of Canada (TSX:RY)(NYSE:RY) would be considered leaders in their industries.
They don’t disappoint. Amazon’s 10-year returns are 32.7% per year. Despite a monstrous market cap of close to $1.7 trillion, AMZN continues to grow at a high growth rate that greatly exceeds the market.
Royal Bank provided 10-year annualized returns of approximately 9.6%, while delivering market-beating income and income growth. Currently, it yields 3.7%.
Watch out for the valuation!
You don’t want to pay for an expensive stock because it could take years for the underlying business to grow into the high valuation. Meanwhile, you could experience zero price appreciation, or worse, in a market correction, the stock can fall substantially from a stratospheric valuation to an earthly one.
Thankfully, internet retailer Amazon stock is undervalued. Its consolidating action could lead to strong near-term upside when it finally breaks out. RBC stock is fairly valued and expected to benefit from future interest rate hikes and the economic recovery post pandemic. Therefore, interested investors could consider adding both stocks to their defensive portfolios.
Seek safe dividends
It’s always reassuring to hold stocks that pay safe dividends. So, consider populating your defensive portfolio with solid dividend stocks. Usually, a stock that has a long history of dividend payments has the means to continue doing so. You can also look at a company’s payout ratio to help determine its dividend safety.
Royal Bank stock historically maintains its payout ratio at about 50%. Its payout ratio this year is expected to be roughly 44% if it maintains its current dividend.
Regulators have banned the big Canadian banks from increasing their dividends in this highly uncertain economic environment. When they lift that ban, RBC stock could make a bigger dividend hike than usual. For reference, its 10-year dividend growth rate is 7.9%.
Sufficiently diversified
It’s generally accepted that holding 10-30 stocks in different industries or sectors is sufficient diversification for a portfolio.
Investors should watch out for over diversification when building their portfolios. That could mean buying similar stocks because you’re bullish on a specific industry. If you buy stocks in the same industry, they’re exposing your capital to similar risks, which is not desirable. They’ll likely move in tandem as well.
Alternatively, you might find many stocks attractive and end up holding more than, say, 50 stocks, which makes portfolio management much more time consuming. As a result, you can’t guarantee a deep understanding of the underlying businesses. And when a market crash occurs, you could be less confident about your holdings and more easily sell at the worst time due to the emotion of fear.
