Suresh Krishnamurthy

T HE search for defensive stocks that can pull investors through the next few months of uncertainty has started in right earnest.

Some research reports proclaim that expectations of improved investment demand may be belied and that valuations are already stretched relative to emerging markets.

Both the Sensex and BSE-500 are down about 8.5 per cent from the high touched in March 2005.

The two-way movement in stock prices has been exaggerated, too, in recent times. In this backdrop, the inclusion of a few defensive stocks in your portfolio may be necessary to withstand the vagaries of the stock market.

Low volatility stocks. Traditionally, defensive stocks usually mean stocks of companies in sectors such as consumer goods, healthcare and banking.

Trends in stock prices over the past few years have, however, changed radically and now, purely in terms of quantitative measure, IT stocks are considered less risky than banking stocks.

This quantitative measure beta is disclosed in NSE’s Web site for Nifty and Nifty Junior stocks. This measure indicates the degree to which the stock was affected in the past 12 months compared to the fall in Nifty.

A beta of more than 1 suggests that the stock price would rise and fall more than Nifty therefore, more risky.

The search is thus for low beta stocks, considered defensive. It, however, would be inappropriate to include only stocks with low beta.

This is because risks other than those related to the market may be higher in such stocks. It would, therefore, be better to pick stocks with low beta and low volatility. The measure of total volatility is also disclosed in the NSE’s Web site.

Some stocks that fit these criteria are ACC, Sun Pharma, Kirloskar Cummins, Punjab Tractors, TCS, Flextronics, Aventis, Asian Paints, Colgate and Siemens.

The beta of these ten stocks is less than 0.75. Their total volatility is also less than that of the average. Investors however need to be aware that the data only refers to history.

These stocks have been defensive in the past 12 months. They may not be as defensive in the next six.

Less downside stocks. Another simple approach to identify defensive stocks is to look at the relative performance of stocks since March 9, 2005 the date on which Sensex and other indices peaked.

Stocks that have suffered less erosion in value since then could be defensive picks.

There is, however, the possibility that the price of these stocks may not go up as much if the market keeps trending up. So, you could choose stocks that have risen more than the average during the bull market and fell less than the average during the bear market.

In the bull market between May 17, 2004 and March 9, 2005, the average increase in stock price was about 71 per cent.

The average drop in price since March 9 is about 8 per cent. This is the average for a set of 208 stocks with market capitalisation of more than Rs 1,000 crore.

Stocks with market capitalisation of less than Rs 1,000 crore were excluded from the list since the threat of sudden drop in liquidity and sharp fall in price is more in such stocks.

Beating the bear market. There are 25 stocks that have risen more than 70 per cent in the bull market and gained even in the bear market since March 9.

Some of these are Hindustan Construction, Bharat Earth Movers, Chennai Petroluem, Sundaram Clayton and MICO.

Another set of 30 stocks rose more than 70 per cent in the bull market and declined less than 8 per cent in the bear market. Some of these are Glenmark Pharma, Gujarat Gas, Crompton Greaves, Gammon India and ABB.

That these stocks beat the market in both phases does point to the expectations having captured the imagination of investors.

Inclusion of a few such stocks in your portfolio could be the appropriate prescription to weather the two-way movement in stock prices that could wreak havoc on a portfolio.

(This article was published in the Business Line print edition dated April 24, 2005)