The best way to pick a defensive stock

Switch off your BlackBerry. Turn off the TV. Stop reading the newspaper. You are taking in too much information, and it’s forcing you to make bad investment decisions.

It sounds like a hypnotist’s mantra, but the advice comes from behavioural investor James Montier, the respected ex-Soc Gen analyst and a member of GMO’s asset allocation team. He suggests you focus on three basic tests instead.

In an interview today, Montier notes: “the great belief is that more information is always better. The problem is that it ignores the fact that the human brain is a limited processing device. We’re not a crazed supercomputer that can handle bytes and bytes of information simultaneously. If you give people more information they actually make worse decisions. So it’s far better to be focused on what matters rather than trying to collect all this information which doesn’t really improve your performance at all.”

So what should you be focused on? Value investing, says Montier, the “only tried and tested method of delivering sustainable long-term returns”. That’s a point he makes forcefully in his new book, “Value Investing: Tools and Techniques for Intelligent Investment” And to find decent value stocks, you need to apply three tests:

• Is the stock cheap? “If it is, it’s a potential investment.  If its not, forget about it there and then”.

• What does the balance sheet look like? A stock needs to be cheap for a reason. “You can’t really analyse earnings without understanding the balance sheet behind those earnings. Yet I feel that a lot of professional analysts have very little grasp of it.”

• What is the management doing with the capital given to them? “Are they going to spend it on their pet projects or something useful.”

He concludes “Wall Street and the City would have you believe that you need to know everything about everything before you make an investment. But to make an investment, what I need to know is actually really limited. Just concentrating on those three things – valuations, what’s on the balance sheet and capital discipline – is enough to get you really thinking of what you’re doing.”

One stock that cuts the mustard is GlaxoSmithKline (LSE:GSK). Third quarter profits rose by a respectable 11%, but the forward p/e ratio is a modest 11, below the FTSE 100 average.