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May 14 2011  / Strategy Article
Defensive Stock
Investing To Beat The Smart Money

Part 3 - Applying The Strategy To Uptrending Stocks

Example - PepsiCo Stock

Part 1 - Smart Money Versus Retail Investor Psyche
Part 2 - Look To The Charts
Part 3 - Applying The Strategy To Uptrending Stocks.


 In this the third and final part of the study of Defensive Stocks, I am looking at PepsiCo. PepsiCo Stock is a great defensive stock, but remember, in a downturn, all stocks fall and PepsiCo is no different. The important aspect is that PepsiCo recovers after every downturn and this is key to having confidence to buy when the stock goes "on sale". Again, this gives me confidence to trade and stay with this great stock. If or once that trend changes, then I will leave PepsiCo and seek out a replacement stock.


I won't go over all the charts that I did for Johnson and Johnson stock. You can review them here. I assume throughout Part 3 that you have read Part 1 and Part 2.

Instead I am going to look at PepsiCo and explain how I would alter my defensive stock investing strategy for staying ahead of the "smart money" managers when it comes to a stock that is in a long term uptrend, like PepsiCo Stock.

There is no way I want to be the investor who buys at the high point in this stock and sells at the low. But unlike Johnson and Johnson stock that had a clear 10 year pattern that was easy to plot, PepsiCo stock has a different pattern. Does this make establishing a trading pattern or Under Value, Over Value and Return Point more difficult? Not at all. But it does require a little bit more study.



Above is the past 10 years of PepsiCo stock. If I was to draw a RETURN POINT based on this pattern alone, it would be difficult. If I picked $60.00 for example as a RETURN POINT, then for much of the past 10 years I would have valued PepsiCo as being UNDER VALUED. If I picked $55.00 or even $50.00 as a strike point, then for much of the 10 years I would have to consider PepsiCo as being OVER VALUED.


But this stock is actually an excellent stock to be in as it was in a general uptrend from 2001 right until 2007. Since then there has been an incredible bear market collapse in 2008 to 2009 and then a recovery, but not to the highs of 2007. Those highs may still be attainable sometime in the future, but that wouldn't concern me right now. Instead I need to set up a RETURN POINT in order to begin my trade within this defensive stock.


The best way to explain how I would apply my defensive stock investing strategy to PepsiCo it would be best to go back in time and restart the trade back in 2001.

If I had been trading in PepsiCo since 2001, based on the strategy I detailed out in Part 1 of this article, it would actually be pretty easy. I would have established a trend line based on JUST the previous year or two at the most.  Let's follow along through the years.


Below is PepsiCo for 2000. In January 2001 I would look back at the previous year. By doing so I would pick $45.00 as the RETURN POINT. Therefore anywhere below is under valued and anywhere above is Over Valued.


This then sets a trend for my trading for 2001. Does it work? Well let's look at the next chart, which is PepsiCo Stock for 2001. The strategy would have worked for the first 8 months. Then a new higher trend emerged. However since I love selling puts, I could have sold puts for the entire year. Starting in August I could have picked $45.00 (the RETURN POINT) and sold there. If I wanted to just buy and sell stock I would have bought stock twice in 2001 and by using stop losses, I would have sold it twice as well.

Then starting in 2002, I review 2001. Therefore my chart for 2001 would be changed to reflect the higher trend that emerged for the last 4 months of 2001. My chart then would look like the one below titled PepsiCo 2001 - new trend for 2002 trading. Going into 2002 my RETURN POINT would be $47.50 based on the stock trend. Choosing the return point is easy based on how often the $47.50 is revisited through the last 4 months of 2001.


So would this new RETURN POINT work for 2002 on PepsiCo Stock?

Since I sell puts it would have worked very well for me. For the first half of the year I would have sold the $47.50 naked put without any assignment. For the last half of 2002 the bear market tumbled the stock and the $47.50 put would be in the money. If assigned shares I could have sold covered calls at the $47.50 strike without losing the shares. All in all, for my method of investing this chart would have worked very well. However for those interested in owning the shares and selling them, 2002 would have been a difficult year unless in December 2001, an investor had purchased shares when they were undervalued and used a stop loss. Through the use of a stop loss, the investor would have been sold out in April to May of 2002. Then based on the under valued zone in the chart below, an investor would have picked up shares in July and held them throughout the remainder of 2002. While not as ideal as the JNJ trade where an investor would be in and out of the shares a number of times during the year, an investor in the shares of PepsiCo would have still made a good profit when they sold out in April and be back in the stock at an under valued level in the summer.

Starting in 2003, based on the bear market and the fall of Pepsico, I could consider adjusting the above RETURN POINT back to $45.00. For 2003 that would have provided a number of opportunities to buy and sell the stock. However if I left the RETURN POINT at $47.50 (which is what I did) there still would have been some opportunities to sell the stock and buy back in. However as my strategy is selling puts, this would have provided another excellent year. I probably would have sold puts at the $40.00 strike to start and then worked myself further out in time. By April my naked puts would be out of the money.

Another advantage of the chart below is the confidence it gives me to purchase shares early in the year as the stock collapsed lower due to the bear market. By the summer of 2003, that confidence would have paid off handsomely and again in the early fall I could have bought shares and then sold them in the early winter. By late December I could again have considered buying more shares in PepsiCo as the stock fell into the under valued zone.

In 2004 PepsiCo recommenced its uptrend as the bear market ended. Again the chart would have worked out well. The stock purchased in 2003 when the stock was undervalued could be sold in early 2004. Then in the fall the stock fell just slightly under 47.50. An astute investor could have bought it again and sold towards the end of 2004. As well, I could have considered moving the RETURN POINT up  in the later half of the year to perhaps $50.00 based on the number of times the stock touched $50.00 in the fall of 2004.

Once more, with my strategy of selling puts 2004 would have been another great year. I would have stayed around $47.50 to $50.00 for my naked put strikes.

Let's skip ahead to the next bear market and see how the defensive stock strategy worked out.

Based on 2006, I would probably have placed my return point around $65.00. Through most of  2007 I would have sold puts at the $65 strike. In the fall I would have found my puts out of the money as the stock rose rapidly to $78.00. In September, I would have had to make a choice whether to raise my return point or stay around the $65.00 strike. In my instance in October 2007 to the year end I sold puts around the $70 strike.



For 2008 the $70 naked put would have been an excellent strike point right up until October when the stock then collapsed. At that stage following the under valued strategy, I could have considered buying stock in the $55.00 to $60.00 range.

By March 2009 PepsiCo stock fell to $45.00. By late summer 2009, my RETURN POINT was moved to $55.00 from $65.00. Interestingly, in the fall of 2008 I would have purchased stock at the $55.00 to $60.00 range and during the fall of 2009, the stock could have been sold for a nice profit. Meanwhile with my selling puts strategy I had another excellent year which you can view the actual trades from 2009 here.  My returns in 2009 were 16.5%

In 2010 the return point was adjusted to reflect the rise in value of Pepsico. I started the year at the $60.00 strike, but by April $62.50 made a very good RETURN POINT. My selling puts trades on Pepsico stock for 2010 can be viewed here. In 2010 my returns were lower than in 2009, at 8.9%. But even at 8.9% the return is quite respectable. However an investor following the chart below, who bought and sold PepsiCo Stock rather than puts, would have earned more than my selling puts strategy.

The charts though are interesting in that they reflect how to adjust them as the years progress and at the same time, constantly end up not owning stock at inflated prices for the year. Even in 2008 when PepsiCo collapsed in the bear market panic, if I had been assigned stock at the $55.00 to $60.00 range, I would have been able to unload it through covered calls into 2009 or 2010.

Finally we come to 2011. The chart below goes back 1 year which also encompasses part of 2010. Based on this chart, my Return Point for 2011 would be at $64.00. You can review my PepsiCo trades for 2011 here. So far this year (as of May 2011) I am already up 8%. As my goal for 2011 is a return of 10%, I do not need to risk much to earn an additional 2%.


Just like the Johnson and Johnson stock trade from Part 1 of this article, you can see in mid April of this year, the "smart money" managers moving into PepsiCo. They have pushed it back up to levels not seen since 2007. Would you say this stock is overvalued at this level? Absolutely.

But my goal needs just 2% more in earnings. To accomplish this and stay within the above chart and not get caught by the "Smart Money" managers, I could consider selling the October 62.50 puts. The chart below shows the put options available as of May 13 2011. The October $62.50 put at .99 would add 1.5% to this year's return bringing my total return to 9.5%. With 3 months left to the end of the year, it should be pretty easy to earn the remaining half a percent to reach my goal of 10%.


However I could also consider the $65.00 put for $1.45 which would bring in 2.2% and reach my goal of 10%. At $65.00 I am selling above the return point, but the 1.45 in put premium earned would place my share value below $64.00 if assigned.

One last course of action would be to let May expire and wait for a pullback in PepsiCo which based on the chart above, I believe will happen perhaps in June or July. With such a fast run up in value, the likelihood of a pullback is quite high. Any pullback would increase put premiums and could drive my gain to 10% quite easily and keep me below the return point of $64.00.



This very simple strategy for use on Defensive Stocks can be applied to any large cap defensive stock. By establishing and adjusting the RETURN POINT each year or throughout the year, I am able to continue selling puts or trading in the stock and still stay within the context of buying the stock or selling puts when in the under valued region and sell the stock when it moves into over valued territory.

By setting a RETURN POINT by simply looking at the stock action for the past 6 months or longer and spotting the mid-range of the trading pattern, I am able to stay away from owning shares in over valued territory. This means I will always avoid owning stocks at high prices, but instead own stocks in under valued prices, which is exactly the opposite of what the "smart money" is wanting the retail investor to do.


I have successfully applied this strategy to the following defensive stocks for more than 10 years. Stocks are listed alphabetically and not in order of importance.

Alberto-Culver Company /Stock  Symbol:  ACV

Altria Group, Inc. /Stock  Symbol:  MO

Anheuser-Busch Inbev SA  /Stock  Symbol:  BUD

Campbell Soup Company /Stock  Symbol:  CPB

Chevron /Stock  Symbol:  CVX

Clorox /Stock  Symbol:  CLX

Coca-Cola Company /Stock  Symbol:  KO

Colgate-Palmolive Company /Stock  Symbol:  CL

ConAgra Foods, Inc. /Stock  Symbol:  CAG

Diageo /Stock  Symbol:  DEO

DUKE ENERGY /Stock  Symbol:  DUK


Kellogg Company /Stock  Symbol:  K

Kimberly-Clark Corporation  /Stock  Symbol:  KMB

Kraft Foods  /Stock  Symbol:  KFT

McDonald’s Corporation /Stock  Symbol:  MCD

Merck & Company, Inc. /Stock  Symbol:  MRK

PepsiCo, Inc. /Stock  Symbol:  PEP

Pfizer, Inc. /Stock  Symbol:  PFE

Procter & Gamble /Stock  Symbol:  PG

Reynolds American Inc /Stock  Symbol:  RAI

Sara Lee /Stock  Symbol:  SLE

Wal-Mart Stores /Stock  Symbol:  WMT

CANADIAN DEFENSIVE STOCKS: Unlike the United States, Canada doesn't really have a lot of defensive stocks. Most Canadian stocks are tied to one industry in general whereas the above USA stocks have a wider base of products and cater to a wider audience of consumers making them a better defensive stock.

Here are the Canadian Stocks I have successfully applied the Defensive Stock Strategy to. Of these stocks I would hazard to say that Fortis Energy, BCE Inc, TransCanada Corporation, Royal Bank Of Canada, Bank of Nova Scotia, Toronto Dominion Bank and Bank Of Montreal are perhaps closest to defensive stock status.

Stocks are listed alphabetically and not in any order of importance:

Bank Of Montreal /Stock  Symbol:  BMO

Bank Of Nova Scotia /Stock  Symbol:  BNS

BCE Inc /Stock  Symbol:  BCE

Crescent Point Energy Corp /Stock  Symbol:  CPG

Fortis Inc /Stock  Symbol:  FTS

Great West Lifeco /Stock  Symbol:  GWO

Power Corporation Of Canada /Stock  Symbol:  POW

Royal Bank Of Canada /Stock  Symbol:  RY

Sun Life Financial /Stock  Symbol:  SLF

Suncor Energy Inc /Stock  Symbol:  SU

Toronto Dominion Bank /Stock  Symbol:  TD

TransCanada Corporation /Stock  Symbol: TRP


Part 1 - Smart Money Versus Retail Investor Psyche
Part 2 - Look To The Charts
Part 3 - Applying The Strategy To Uptrending Stocks.


Disclaimer: There are considerable risks involved in all investment strategies. Trade at your own risk.
Stocks, options and investing are risky and can result in considerable losses. None of the strategies, stocks or information discussed or presented are financial advice, trading advice or recommendations. is a private website. Everything presented and discussed are the author's ideas and opinions only.
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