With the Aussie economy going through a challenging period and the outlook for the ASX being relatively uncertain, defensive stocks are likely to become more popular over the medium term. That's not to say that cyclical companies are worth avoiding, but rather that those companies which have a lower correlation between their earnings outlook and the performance of the wider economy could perform relatively well.
Defensive characteristics
That's a key reason why I'm upbeat about the prospects for pharmaceutical company, CSL Limited (ASX: CSL). Historically, pharmaceutical companies have been less reliant upon the performance of the wider economy and, as a result, have been viewed as relatively appealing stocks to own during turbulent periods for the wider index. In fact, CSL has a beta of just 0.6, which indicates that its shares should move by 0.6% for every 1% change in the level of the wider index. As such, CSL's volatility should be low and cause investor sentiment in the stock to improve relative to its more cyclical peers.
Growth prospects
Furthermore, CSL also offers excellent growth prospects alongside its defensive merits, with the company's bottom line forecast to rise by over 20% per annum during the next two years. This, though, is perhaps to be expected, since CSL has delivered earnings growth of 21% per annum during the last ten years, with excellent cost control helping it to boost margins and improve upon sales growth of 11% per annum during the same time period. And, at a time when few ASX companies are offering such strong growth rates, it is likely that demand for CSL's shares will remain robust – especially when the chances of it meeting its guidance are relatively high.
Dividends
Meanwhile, CSL's dividend appeal may be somewhat lacking at the present time, with it yielding just 1.6%, but this could be set to change. The key reason for this is that CSL has a very modest payout ratio of just 42% and, while it needs to reinvest in order to pursue future growth opportunities, it could easily afford to do so while paying out a greater proportion of profit as a dividend. And, with profits set to increase rapidly (as mentioned), CSL is expected to more than double dividends in the next two years, which may improve its income appeal moving forward.
Valuation
Of course, CSL's defensive characteristics, track record of growth and future growth prospects mean that it trades at a premium to the wider market, with it having a price to earnings (P/E) ratio of 23.4 versus 15.9 for the ASX. However, when its growth rate is combined with its rating, it equates to a price to earnings growth (PEG) ratio of just 1.16. This indicates that growth is on offer at a reasonable price and that CSL's share price looks set to continue the run that has seen it soar by 30% in the last year.
