Author: Walter Lu, Covestor Flexible Value Model
October 4, 2010: Some of my favorite stocks today are defensive, high-quality mega caps, such as WMT, JNJ, NVS, etc. Investors are worried about current economic problems, and many have shunned equities because they believe they will perform poorly in a slow economy. Yet some of the biggest and most well-known companies in the world are stronger than ever.
Take a look at their financial performance and you wouldn’t be able to tell that they just went through the worst financial disaster since the Great Depression. Investors don’t seem to realize that when you buy stocks, you aren’t buying the economy, you are buying a business that may or may not be dependent on the economy.
Some companies and sectors are very resilient and not that sensitive to the economy, and because of the absence of this source of uncertainty, deserve a higher valuation. However, the exact opposite seems to be happening, in that many defensive names are actually historically cheap. I believe that this is a mispricing by the market, and buying defensive, high-quality mega caps at current prices is a very good opportunity. If you are willing to hold for the long term, this looks to me like a medium/high-reward, high-percentage, very low risk bet. I am currently holding the majority of my real life portfolio in these stocks.
However, you might have noticed that I don’t hold any stocks of this type in the Flexible Value portfolio. This is for a couple reasons. First, I believe in diversification across many attributes, including market cap. I don’t think diversification is the end-all for portfolio management – far from it – but if you can get it without giving up too much in returns, then why not? Second, I believe that on average, large caps do look like a better bet than small caps, but I am not buying the average. Since there are so many more small cap stocks than large caps, usually the majority of the best opportunities in the stock market are in the small cap space. In the Flexible Value portfolio, I try to look for these opportunities, but if I cannot find any to my liking, I am not against moving into large caps or cash. As the name of the portfolio suggests, I try to be flexible.
