Why CSL Limited is one of the best stocks on the ASX

Some of my best investments have been in the healthcare space. It’s not difficult to see why, since the sector offers a potent mix of growth and defensive prospects.

This means that companies such as CSL Limited (ASX: CSL) or Cochlear Limited (ASX: COH) in the healthcare sector have the potential to record strong share price rises whatever the market conditions.

Take right now as an example.

Global stock markets are exceptionally volatile following Brexit and in fact fell heavily in the first couple of days after the result was announced. The ASX slumped by over 4% within two days of Brexit and yet CSL’s share price was still at breakeven at close on Monday June 25. It has now risen by 3% since Brexit was announced, while the ASX is still down by 1%.

This defensive appeal centres on the fact that CSL’s financial performance is less positively correlated to the economy than is the case for almost all non-healthcare stocks. Its pharmaceutical, vaccines and plasma segments are more closely linked to the outcome of R&D rather than the result of a referendum.

This appeals to investors whether they are risk-on or risk-off, since it means there is growth potential whether the wider economy is performing well or not.

CSL and many of its healthcare stocks also have appeal to private and institutional investors alike because their share prices tend to move by less than the index in the short run. By this, I mean that their shares are less volatile than the ASX and this means that they can help reduce the overall volatility of a portfolio. This makes them even more popular choices during volatile times like the present.

For instance, CSL has a beta of 0.6 and this makes it 40% less volatile than the ASX on paper. In my experience this figure is low even for a healthcare company and this goes some way to explaining why CSL is 4% higher than the ASX in the post-Brexit world.

Clearly, CSL’s 255% share price rise in the last five years is not just down to external factors in terms of investors seeking out defensive growth stocks. It is also performing well as a business, too. For instance, CSL’s strategy is focused on expanding its geographic reach and also in investing heavily in its commercial capabilities to take advantage of new product launches such as its novel recombinant coagulation products.

Further, CSL is investing in its R&D capabilities and has the cash flow to do so. Free cash flow stood at just over US$1bn last year and while investors may feel that a greater proportion than 53% of this figure should be paid as dividends, I think that CSL should maintain a modest payout ratio. That’s because in my view CSL can allocate capital to high-growth projects more efficiently than its investors.

And besides, investor sentiment is high due to CSL’s annual forecast EPS growth of 13% over the next two years, so rapidly rising dividends are unnecessary in my view.

So, with the healthcare sector offering prime defensive growth opportunities and CSL having the strategy, business model and financial performance to push its share price higher, in my view it remains one of the best stocks to own on the ASX.

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Motley Fool contributor Robert Stephens has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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