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The Great Rotation Into Defensive High-Yield Stocks

Wednesday - 5/1/2013, 1:20am  ET

LONDON -- It's been called the Great Rotation, the switching of investors' appetite from government bonds into equities.

Investors have been losing faith in the safety of bonds, as quantitative easing has pushed interest rates to unprecedented lows and stoked fears of future inflation. At the same time, the newly minted money has found a home in equities, especially since Mario Draghi reduced tail risk by saying the European Central Bank would do whatever it took to save the euro.

A significant feature is the preference of investors for shares in defensive sectors that are paying decent yields. They enable shareholders to enjoy the income and relative safety associated with bonds in more normal times.

That's chased the price of such stocks to exceptional highs. Fortunately, the growth opportunities for defensive sectors in emerging markets mean investors don't need to be unduly concerned about valuations.

Diageo
Diageo  is a perfect example. Its shares are trading on a trailing price-to-earnings (P/E) ratio of 27, nearly double the FTSE 100 average P/E. According to my data, which shows the historic year-end P/Es, the shares are as highly rated as they ever have been this century.

Applying its global distribution to new emerging markets has powered much of Diageo's growth. Yielding 2.2% and with a prospective P/E a more palatable 20 times, a recent fall of 6% from last month's all-time high might present an opportunity to pick up this stock.

Unilever
There has been a more modest pull-back of just 2% in Unilever's all-time high after the company revealed sluggish growth in Europe this month. Its trailing P/E is 23, above the range it has traded in for the last 10 years, also dropped to 20 on prospective earnings. With strong global brands that have a defensive nature in developed markets and appeal to emerging market consumers, its stock also has bond-like qualities.

BATS
That's a market characteristic shared in spades by British American Tobacco . Western consumers are stuck on the product, and emerging market populations are acquiring a taste for global brands. Its shares are just a tad off their all-time high and at the top end of their historic rating, though a trailing P/E of 17 is nearer the market average.

A prospective yield of 4.2% makes BATS an appealing income stock.

A core of safe, income-generating stocks makes sense in any portfolio, even if they are expensive. That's why The Motley Fool has produced a new report: "5 Shares to Retire On." It details five companies that have dominant market positions, healthy balance sheets, and robust cash flows, qualities that underpin their reliability and future dividends. Whether you're saving for retirement or for any other purpose, I recommend you have a look at these five shares. You can download the report by clicking here -- it's free.

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This article was originally published as The Great Rotation Into Defensive High-Yield Stockson Fool.com

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