Defensive stocks perform consistently regardless of the economic conditions. These stocks are less prone to market volatility, and economic cycles that can negatively impact cyclical stocks. Investors can expect steady returns and consistent stock prices from defensive stock. These stocks offer several benefits to investors.
What are defensive stocks?
Defensive stocks demonstrate relatively stable performance as compared to the overall market. They are also considered non-cyclical stocks. These stocks are from companies that offer basic consumer goods and other essential services or products. Consumers buy these products and services regardless of the economic conditions.
They are not directly affected by economic downturns and recessions. Often, these stocks are characterized by stable prices and low volatility. However, the converse is also true when the market experiences expansion. They will offer lower returns when compared to cyclical or growth stocks.
Defensive stocks can be useful for investors during economic recessions. These stocks comprise companies with consistent cash flows, revenues, and profits even during recessions.
A wise strategy for investors can be to balance the portfolio with cyclical and non-cyclical or defensive stocks. This way, investors can diversify and achieve returns in different moments of an economic cycle. Protecting the portfolio with defensive stocks is a wise investment strategy.
How to identify defensive stocks?
Investors can evaluate the historic performance of different stocks to establish which ones can be categorized as defensive or non-cyclical stocks. A few important characteristics that define these stocks are listed here.
They are usually associated with their past success. It does not mean that young and growing companies cannot offer consistent returns. However, defensive stocks would perform consistently over years through economic turmoil as well.
Overall, these companies will be in business for several years. They would accumulate billions of profits through retained earnings over these years.
Consistent profits and dividends
Since defensive stocks generate consistent revenues, their profits tend to be consistent over the years as well. Once these companies are profitable, they maintain their profitability in the long run.
Similarly, these stocks will adopt the constant dividend policy that pays regular dividends.
Low volatility - low beta
Beta measures the volatility of a stock price in relation to the broader index. They will have a beta value of less than 1. It means these stocks will be less volatile to market fluctuations as compared to the total market volatility.
Although it isn’t a hard rule, defensive stocks come from specific industries. These industries include utilities, energy, health care, and other consumer staples.
A common theme of these companies is their consistent demand. These products and services are necessities. Therefore, consumers buy them regardless of the market conditions.
Defensive stock examples
One way of identifying these stocks is to look for specific industries and companies in these sectors.
- Consumer Staple: These companies sell basic food items, beverages, tobacco, and necessities for households.
- Utilities: These companies offer products that include electricity, water, gas, and other utilities.
- Telecommunication: Telecommunication stocks also thrive in economic recessions; hence they form good examples of non-cyclical stocks.
- Healthcare Sector: Insurance, pharmaceutical, and hospitals would continue their operations regardless of the market conditions.
- Retail Sector: Historically, the retail sector also performs well in economic recessions. Thus, these companies can also be considered defensive.
Advantages of defensive stocks
Investing in these stocks can offer several advantages to investors.
- Defensive stocks offer stability to investors in volatile market conditions. Investors can include these stocks to lower the total portfolio volatility.
- These stocks offer consistent dividends in economic downturns.
- It can be a good starting option for beginner investors.
- Defensive stocks are ideal for risk-averse investors. As these companies maintain a low-risk approach and protect investors’ wealth.
- These stocks often outperform the market in economic recessions when most stocks perform badly.
Disadvantages of defensive stocks
Investing in these stocks can also come with some disadvantages for investors.
- They underperform during market expansion times. In some cases, these stocks will maintain a steady and low growth rate even during an economic boom.
- Since these stocks exhibit a low beta value, it means the upside risk or potential benefit during the volatile markets is also limited. It means there are limited gains for investors during high volatility periods.
- These stocks also experience slow growth rates that might not be suitable options for growth investors.
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