As the September 7th kick-off of this year's NFL season approaches, we're reminded of the importance of both strong offensive and defensive lines of players in both football and investing.
Using value and growth models based on investing greats we highlight a few stocks to consider in both the offensive and defensive portions of one's portfolio.
Charlie Munger, has said, "A lot of people with high IQs are terrible investors because they've got terrible temperaments." Having the discipline and patience are key ingredients to investing success.
As the September 7th kick-off of this year's National Football League season approaches, we're reminded of the importance of both strong offensive and defensive lines of players. The same argument holds true in terms of a winning investment portfolio. Building a resilient, well-performing "team" involves incorporating both "offensive" and "defensive" holdings to ensure the best probability of success.
Bear Bryant, who served as head football coach for the University of Alabama for 25 years (and led the team to six national championships and 13 conference championships), once summed up his recipe for success this way: "Offense sells tickets, but defense wins championships." While fancy plays and ceremonious touchdowns draw excited fans to the stadiums, Bryant believed that it was the less glamourous, disciplined process of keeping the opponent out of the end zone that made the biggest difference in a team's level of success.
The same holds true for investing. Hot stocks and titillating tips gathered at parties or family get-togethers may sound tempting and smack of a potential "lottery" win, but they rarely (if ever) are. Like a "Hail Mary" play on the football field, it might pay off, but it's a last-ditch effort that players are forced into within the last few seconds of the game rather than a winning strategy over the long term. Similarly, successful investors are those that establish a solid approach to assemble portfolios of fundamentally sound companies, and stay true to that investment approach through thick and thin.
At Validea, we use stock screening models that I created based on the tried-and-true investing philosophies of market legends such as Peter Lynch, James O'Shaughnessy and Warren Buffett. The models allow us to identify companies with strong underlying fundamentals and sustainable businesses that may be better equipped to weather inevitable market ups and downs. This allows investors to strengthen their defensive line, so to speak, and focus on preserving capital and enjoying returns over the long run, rather than hitting the proverbial (and elusive) jackpot in the near term.
Offensive and Defensive Stocks
Offensive picks would include those stocks positioned to take advantage of market upside, including value stocks (those that are selling cheaply relative to the underlying values of their businesses) as well as growth stocks (those with strong earnings growth potential). Defensive stocks, on the other hand, might include non-cyclical, "household name" businesses that boast size and strong competitive advantage. These companies generally provide basic-need and widely-used products (think food, railroads and insurance) and/or repetitive consumer services that don't require hefty capital expenditures. Such names, which might also pass muster under value strategies, would provide a level of insulation against market disruptions while enjoying predictable, steady cash flow.
An investor can assemble a rugged offensive line using the tenets of value investing legends such as Benjamin Graham, David Dreman and John Neff. While the methods of these gurus may differ, they share the philosophy that buying solid companies at discounted prices makes sense, while chasing the newest, hottest stocks might not. Some names that pass these respective screens include: Taro Pharmaceutical Industries Ltd. (TARO); Verizon Communications (VZ); and global automotive supplier Magna International Inc. (USA) (MGA). By adding growth criteria to the mix, an investor can round out its offense with companies that exhibit Growth at a Reasonable Price (GARP). Peter Lynch, for example, used his hallmark price-earnings-growth ratio (P/E/G) to ascertain whether a company's P/E is supported by increased profitability. Our Lynch-based stock screen favors companies such as Bank of New York Mellon (BK).
For the defensive side, we’ll tap strategies from the likes of Warren Buffett, which is a high-quality value model that tends to select companies with consistent track records of earnings and profitability, and the Cornerstone Value approach (a model inspired by quant guru James O’Shaughnessy), that identifies the largest stocks in the market with strong cash flow and other favorable characteristics (which are then sorted by dividends to select the names with the highest yields). Our Buffett-based model, for example, favors professional services company Accenture PLC (ACN) while our O'Shaughnessy-inspired model likes French insurance company AXA SA (OTCQX:AXAHY). The names tagged by these types of models tend to be solid, reliable businesses that produce straightforward, non-cyclical products and/or services, have a conservative debt structure and generate income through dividends. When the offensive team is not on the field or putting up points, you hope your defensive line-up is grinding it out, showing solid productivity and generating income.
Beyond the Line of Scrimmage
Creating a portfolio that incorporates both an offensive and defensive mindset, however, requires more than focusing on asset allocation and diversification--it also has a lot to do with your emotional approach to investing. Warren Buffett's right-hand man, Charlie Munger, has said, "A lot of people with high IQs are terrible investors because they've got terrible temperaments." An investor's personality can be one of the biggest impediments to investing success, particularly if they are prone to making impulsive decisions based on market noise.
Investing, by definition, is a long-term endeavor intended to make your money "grow", and the stock market can offer investors solid returns over time. To be successful, however, investors should exercise restraint and exhibit both patience and foresight. Having a solid offensive and defensive playbook can help grow and compound your wealth over time but a key is making it through the entire investing season healthy so that you are around to play in the next game.
Disclosure: I am/we are long TARO, VZ, MGA, BK, ACN & AXAHY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.