Well-known outperforming fund manager Neil Woodford built his portfolio on the expectation that it will receive little help from macroeconomic trends, he reckons.
If the firms hes holding are to deliver on investor total returns, they need to stand on their own merits and achieve advances by hard-earned business growth, operational efficiency, and effective execution of their strategies.
Defensive enterprises
With so many uncertainties in the world and on the markets, adding a defensive element to my share portfolio is an attractive proposition. Mr Woodford must believe that the shares he holds have at least some level defensive quality to them.Thats why Im looking at three firms featured in the top ten largest holdings of the CF Woodford Equity Income Fund: BAE Systems (LSE: BA), Capita (LSE: CPI) and Legal & General Group (LSE: LGEN).
A dividend on security
Shares in British multinational defence, security and aerospace companyBAE Systems doubled by March 2015 after hitting a low at the end of 2011. Since then the shares have eased around 14%.
Those invested in BAE Systems since the end of 2011 will have enjoyed seeing their capital grow due to the rising share price, but the defence sector attracts for the consistency of cash flow that firms can generate from their operations. Its easy to imagine worldwide trouble leading to on-going demand for weapons and the like. If BAE Systems can keep winning contracts, the cash earned should power the dividend into the future.
At todays 450p share price, the forward dividend yield runs at around 4.8% for 2016 and City analysts following the firm reckon forward earnings will cover the payout about 1.8 times. Right now we can pick up the shares on a forward price-to-earnings (P/E) multiple around 11, which isnt a big stretch given the dividend yield available and predicted growth in earnings of 6% during 2016.
A countrys defence needs dont really follow macro-economic cycles, so demand for BAE Systems services and products should continue whether the macro-cycle is down, or up, or somewhere in the middle. As such, BAE Systems could be a good defensive investment for my portfolio.
Steady growth in outsourcing
Capitas customers outsource non core functions to Capita, such as administration, ICT, HR, payroll, strategic development, and business process engineering. Such a strategy seems popular with firms these days because they can improve efficiency. Outsourcing companies like Capita tend to execute well (at least thats the theory), as they focus on the task without distraction from the other operational demands of the client companys main business.
Once Capitas services become engrained into a firms operations, I reckon its hard for those companies to switch outsourcing suppliers without major disruption to their businesses, so they probably tend to stick with Capita. Perhaps thats what gives Capita the defensive qualities that Neil Woodford hunts for and why Capita puts in consistent year-on-year revenue increases.
Capitas valuation is more challenging than BAE Systems. At todays 1207p share price, the firms forward P/E rating runs at almost 16 for 2016 with City analysts predicting an 8% uplift in earnings that year. Meanwhile, the forward dividend yield is about 2.9% with earnings covering the payout more than twice.
Capita is tempting, but the yield is low and the valuation hot. Im going to watch in the hope of a better-value entry point.
This one is cyclical
At todays 252p, Legal & Generals share price has increased more than nine times since the nadir established during 2009. Theres good reason for that: financial and insurance firms are cyclical. On that measure Legal & General is the odd one out among this selection of Neil Woodfords holdings.
Right now, the forward dividend yield runs at almost 5.7% for 2016 with forward earnings expected to cover that payout about 1.4 times, which looks low to me. The forward P/E rating runs at just over 12 and City analysts reckon earnings will grow 7% next year.
The valuation looks reasonable, but earnings could fall sharply in any downturn. Id be surprised to see Mr Woodford holding on to Legal & General through thick and thin. That said, the company has been doing a lot right recently, judging by investor total returns over the last few years. To be holding now, Neil Woodford must see further progress ahead; however, Im going to sit this out and cheer investors on from the sidelines.
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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.