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3 Defensive Stock Plays for Your Portfolio

Beware of three hidden traps in the economy

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How to Play Defense

With all these perils, and many others, strewn around, you might think I would be advising you to head for the hills. But I’m not. We’ve already taken significant defensive measures in our model portfolio by trimming our overall stock weighting to 51%. The other 49% consists of bonds, with an emphasis on short to intermediate maturities.

If you share my concerns about the risks in the current environment, the first thing you should do is make sure you’ve got enough assets allocated to fixed income. Bulk up on the low-risk Weitz Short-Intermediate Income Fund (MUTF:WSHNX). It hasn’t had a losing year since 1994. The fund’s shares are available through leading discount brokers, and carry an affordable $2,500 minimum. Current yield: 2%.

Once you’ve set your fixed-income stake, you can nibble selectively at our recommended stocks.

This month, I suggest focusing on companies that churn out huge amounts of free cash flow (excess cash
above what’s needed for operating purposes). If the market does run into trouble later this year, these
outfits have the financial muscle to buy back shares and cushion the blow.

Furthermore, businesses with ample cash hoards can take advantage of stock market declines by acquiring other businesses at bargain prices. Among my favorite cash gushers right now, two make their home in the healthcare space. Regardless of whether the 2010 healthcare act is retained or repealed, these players are poised to grow at a robust pace for years to come:

AmerisourceBergen (NYSE:ABC). One of the nation’s largest drug wholesalers, ABC is a model of consistency. Earnings per share have soared almost 400% in the past 10 years, with gains in nine of the 10 annual frames. Along the way, the company has wisely used its burgeoning free cash flow for easily digestible tuck-in acquisitions and aggressive stock buybacks. Since 2006, ABC has shrunk its share count by a third—a “virtual dividend” of 7.6% a year. Combine that with the stock’s cash yield of 1.4%, and you’ve got a low-risk investment with a high probability of beating the market indexes over the long haul.

Wellpoint (NYSE:WLP). This leading health insurer funnels its surplus cash right back into shareholder pockets. Over the past five years alone, WLP has retired a stupendous 45% of its outstanding stock. What’s more, the company expects to spend another $2.5 billion on buybacks in 2012.

As a result, each surviving share enjoys a rapidly increasing proportionate claim on Wellpoint’s profits. Assuming the buybacks continue at the same pace over the next five years as in the past five, earnings per share will grow 83% even if the firm’s total profits remain flat!

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