Do you want to build a stock portfolio that’s defensive and of high quality?

The question has been answered in several ways by early investors who discovered some basic truths about investing. First, you should choose stocks that have demonstrated great price stability over a long period of time. Second, you should choose stocks that pay a dividend and have a history of regular dividends.

Only then do you identify stocks with long-term earnings growth — not necessarily sizzlers with spectacular returns, as they are usually expensive and, therefore, riskier. To find one such stock emerging in a portfolio is nice, of course. The goal is to find companies that have been stable market performers in addition to being steady dividend payers and that have managed to grow most years.

In constructing a portfolio of Canadian stocks for a defensive client, the long dividend history is a limitation. Few companies that trade in Canada have records of more than 10 years of consecutive payments. You can, though, find dividend-paying stocks that have been very stable over the years. Price stability, according to pio-neer investment researcher Arnold Bernhard, is the most significant factor in identifying a quality stock.

Bernhard founded Value Line Inc. in New York in the 1930s. His successors have built on Bernhard’s solid analytical methods. The long-term success of the firm’s top-ranked stocks — almost all in the U.S. — is evidence of their work’s validity.

In 1959, Bernhard published a book explaining his methods, which were still viewed in the investment world as something out of an alchemist’s lab. The book is valuable because it lays out a simple arithmetical formula for determining stock price stability. Using high, low and average annual price data for 11 years, Bernhard’s formula easily quantifies price stability for a stock. And it has another positive attribute: it takes into account a secular price trend and prevents it from exaggerating volatility.

Rather than this being a “how to” report, we have done the work for you. The accompanying table lists Bernhard-method stability numbers for 40 Canadian dividend-paying stocks that have traded for at least 11 years. The 40 have had the most stable price action out of a group of 130 dividend-paying stocks.

Keep in mind that the stability ratios have meaning only when compared to each other; the numbers themselves have no significance. The table lists them from most stable price action (low stability ratio) to least stable (high ratio).

The table contains two more pieces of information to help in investment selection: each stock’s market capitalization and current dividend yields.

Market cap is another basic way to determine the relative quality of a stock. This has been central to the method of analysis developed by Canadian money manager George Armstrong more than 60 years ago.Market cap will help you select appropriate issue size for a portfolio, with “large” being conservative and “small” being higher-risk or speculative. Large companies have higher quality because of their size. They enjoy competitive advantages in business. They have the resources to cope with a crisis, to invest in new projects and to diversify.

You realize Canadian investors have a problem with dividend-paying stocks when another early investment researcher, Benjamin Graham, said a defensive-minded investor should look for companies that have paid dividends for at least 20 years.“Inherent stability” in a stock has particular appeal in investment analysis, Graham wrote, although he was thinking primarily of earnings stability. But price stability results from earnings stability and stable growth. IE