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Written by Elizabeth Aldrich; edited by Richard Richtmyer
Updated
2022-07-22T19:53:13Z
- What is a defensive stock?
- Which industries have defensive stocks?
- Defensive vs. cyclical stocks
- Advantages of defensive stocks
- The bottom line
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- Defensive stocks provide consistent returns, regardless of conditions in the broader stock market or the economy.
- Defensive stocks typically belong to well-established companies that offer goods and services people always need.
- Defensive stocks protect a portfolio from losses, but tend not to offer much growth potential.
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Most people invest for appreciation — to have their money grow. But growth isn't the only goal worth considering. A smart investment strategy also protects a portfolio, shielding it against financial downturns.
Defensive stocks function as their name suggests. They defend an investment portfolio against losses. While they don't offer huge growth potential, defensive stocks perform consistently even during periods of economic decline, when other equities are tumbling.
Like a bulwark against erosion, defensive stocks can prevent your portfolio from substantially losing its value during a recession or bear market.
What is a defensive stock?
A defensive stock is one that can be relied on to provide consistent returns even during an economic or market downturn. These companies typically offer goods or services that people continue to buy even when the economy isn't doing well.
There are no hard and fast rules to define a defensive stock, but there are some general guidelines you should look for:
- History of success: The company is established and very large. It has a couple of decades in business, at the very least, and a total market value in the billions is a reasonable threshold.
- Consistent dividends: The stock has consistently paid dividends over a long period of time — 10 years or longer.
- Low volatility: The beta coefficient, which measures a stock share's movements compared to the overall stock market's, is low — ideally below 1. This indicates that the stock isn't greatly affected by market swings. The beta coefficient is a complex economist's tool, but you can often find it in analysts' reports on a company, or it may be included in its online stock listing.
Conservative investors and investors who are seeking to preserve capital often lean toward defensive stocks because of their reliability. More aggressive investors may avoid defensive stocks altogether and protect their wealth by maintaining a buffer in cash and bonds.
However, a mix of both is usually wise. By developing a strategy that includes a healthy balance of defensive and cyclical stocks in your portfolio, you're able to shield against total loss during a downtown and make the most of periods of economic growth.
Which industries have defensive stocks?
Defensive stocks are usually found in these fields or sectors:
- Utilities: Companies in the electric, water, gas, and waste management sectors offer necessary services, and continue to operate as usual through economic downturns.
- Consumer staples: When consumers are cutting their budgets down to bare-bones necessities, staples like household goods, toiletries, tobacco products, and food and beverages likely won't be eliminated. Within these, it can be smart to opt for companies that prioritize affordable brands.
- Health care: Health care is another good or service that consumers will continue to purchase in an uncertain economy, and for that reason, it's performed well over through recessions in the past. This sector includes insurance, pharmaceuticals, medical devices, and hospitals.
- Telecom: Telecommunications, which includes cable, phone, and internet service providers, are services that consumers never stop needing. They might cut back on or downgrade during hard times, but for the most part, these businesses have pretty stable revenue.
- Discount retailers: When the economy weakens, consumers pivot toward value. While most retailers tend to suffer during a recession, the ones that do well are those that help people get the best bang for their buck. These are companies that operate with large economies of scale and offer lower prices relative to their competitors.
These are the traditional defensive sectors. But it's possible for a company that's not necessarily in a "recession-proof" industry to still have stock that's considered defensive because of the company's size, history, and proven ability to adapt to changes in the market.
For example, some investors might argue that certain giants in the tech sector — like Amazon and Alphabet (Google's parent company) — are prosperous, life- and industry-dominant, and adaptable enough to be considered defensive stocks.
At the same time, just because a stock is in a defensive sector doesn't necessarily make it a defensive stock. It still has to meet some of the other guidelines mentioned above, such as consistently paying out dividends for a long period of time and having an established, sound financial track record.
Defensive stocks advantages and disadvantages
While defensive stocks can bring many advantages, they also have their drawbacks. It's important to carefully consider both before investing.
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The bottom line
In the end, a defensive stock is any stock that performs consistently regardless of changes in the market. While looking for stocks in defensive sectors is a good starting point, it's more important to pay attention to the relevant features of an individual stock (company size, dividend payout, and historical returns) that suggest it will perform defensively.
Defensive stocks can help you preserve wealth and protect yourself against losses during a recession. However, these stocks are unlikely to provide supercharged growth.
Conservative investors and those who are investing to preserve capital often lean toward defensive stocks because of their reliability. More aggressive investors may avoid defensive stocks altogether. Living by the motto that "offense is the best defense," they prefer to bet on cyclical stocks that offer waves of high growth they can ride out through periods of economic decline. Or, they protect their wealth by maintaining a buffer in cash and bonds.
In the end, defensive stocks are just one way to mitigate risk in your portfolio. Most investors will want a diversified strategy that combines them with the right cyclical or growth stocks. Like most things in life, investing is all about finding the right balance.
Elizabeth Aldrichis a finance writer specializing in credit cards and loans, retirement planning, investing, economics, and small business. Her work has appeared on The Motley Fool, USA Today, MSN Money, Yahoo! Finance, Bankrate, and Business Insider. She's an avid credit card points collector and perpetual traveler.
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