UK Stocks that may not be as defensive as perceived

UK Stocks that may not be as defensive as perceived

Investors on one hand are getting as many stocks that have been perceived as defensive as possible. The popular stocks are in major sectors like consumer staples, business services and engineering, consequently pushing their valuations to ever higher levels. Companies in this category are believed to be of high quality with amazing defensive and predictable earnings streams, with minimal exposure to the UK economy. However, it is worth noting that most of such stocks are currently trading on valuation multiples that are far in excess of where they were at the top of the last cycle in 2007.

Another point to note is that while there are companies like Unilever or Diageo that are genuinely defensive, others like Spirax-Sarco or Halma have been identified to be exposed to cyclical-end markets. This means that their earnings potentials can be significantly affected by a downturn of events. The combination of high valuation and earnings risk, consequently make these stocks much less defensive than commonly believed.

On the other side of the coin are stocks that have obvious risks attached to them. Brexit-related UK economic exposure or structural issues are some of the several factors that could affect the value of stocks, and are in many cases trading at extremely low valuations. Mid- and small-cap stocks with domestic UK exposure are found in this category, particularly where sentiment is extremely depressed and liquidity has dried up.

The stock market has already discounted a bad outcome in these situations. In some instances, this may be justified, particularly where there are real negative long-term structural trends that impact business models like the retail sector.

Sectors as the travel and leisure and property sectors where the stock market may be too bearish provide an opportunity for investors to find companies that are structurally well positioned with strong balance sheets and moderate cyclicality, yet with very attractive valuations.

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