Defensive Stocks: A Guide to Stable Investments

A defensive stock is a stock that demonstrates relatively stable performance regardless of the current state of the economy. Defensive stocks are also called non-cyclical stocks, as they are less prone to the economic cycleEconomic CycleThe economic cycle is the fluctuating state of an economy from periods of economic expansion and contraction. It is usually measured with the of expansions and recessions. Defensive stocks will come with a steady dividend payment and a more constant share price.

During an expected recessionRecessionRecession is a term used to signify a slowdown in general economic activity. In macroeconomics, recessions are officially recognized after two consecutive quarters of negative GDP growth rates., investors usually add defensive stock to their portfolios, as they are expected to perform well despite the economic downturn. On the other hand, cyclical stocks mirror the economic cycle by thriving during economic upswings and suffering during a downswing.

Summary

• Defensive stocks are also called non-cyclical stocks. They are expected to provide a steadier dividend and a constant share price.
• Common defensive stocks are companies that produce necessities, such as utilities, healthcare, or consumer staples.
• They act as safe assets that reduce portfolio variability and protect investors during recessions.

Identifying Defensive Stocks

Beta measures a stock’s volatility in relation to the overall market. Defensive stocks usually come with a low beta because they are less affected by market swings.

Defensive stocks also traditionally come from sectors that produce necessities or consumer staples. Consumers who purchase such goods or servicesProducts and ServicesA product is a tangible item that is put on the market for acquisition, attention, or consumption while a service is an intangible item, which arises from will do so regardless of a recession. They also won’t buy excess of the goods or services even if money is available to spend if the economy is booming.

Examples of defensive stocks include utilities, such as electricity, water and heating, and essential household items, such as soap, detergent, and groceries.

Why Invest in Defensive Stocks?

1. Helps reduce portfolio volatility

The defensive stock in many portfolios acts to reduce portfolio volatility. During economic recessions, investors will rely on defensive stocks to protect them from further losses. Defensive companies also provide a high dividend yield in a bear market, which makes it an attractive addition to an investor’s portfolio.

2. Serves as a viable option for less experienced investors

For investors who do not know much about the stock market, defensive stocks are a good option to start out. They allow investors to get a feel for the market first without requiring them to burn through their capital with more aggressive stocks.

For the risk-averseRisk Averse DefinitionSomeone who is risk averse has the characteristic or trait of preferring avoiding loss over making a gain. This characteristic is usually attached to investors or market participants who prefer investments with lower returns and relatively known risks over investments with potentially higher returns but also with higher uncertainty and more risk. investor, defensive stocks are a suitable choice. It lowers the risk substantially while offering an appropriate reward.

3. Provides a steady revenue stream (through dividends)

Defensive stocks are also a good means of making income aside from shares trading. It generally provides the best dividends in both bull and bear marketsBull vs BearThe term bull vs. bear denotes the ensuing trends in stock markets – whether they are appreciating or depreciating in value – and what is the, giving investors a steady revenue stream.

Lastly, there are periods in the year where the markets are neither bearish nor bullish – instead, it is highly volatile. In such circumstances, defensive stocks are one of the best investments to protect an investor’s capital and reduce risk.

Practical Example

The 2020 coronavirus pandemic’s caused substantial volatility with large stock market drops, causing many investors to panic. While the Dow Jones Industrial Average (DJIA), S&P 500, and Nasdaq plunge throughout the pandemic, defensive stocks become a safe haven for fearful investors.

B&G Foods Inc (BGS) is an example of a defensive stock that’s been able to offer a stable return on investment during the pandemic. The company manufactures, sells, and distributes shelf-stable foods, frozen foods, and household products. During the first six months of 2020, the company’s shares rose 36%.

In comparison, American Airlines (AAL) is an example of a cyclical stock that is highly affected by the economic cycle and was especially impacted by the pandemic.

Related Readings

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• Cyclical IndustryCyclical IndustryA cyclical industry refers to an industry whose revenue generation capabilities are tied to the business cycle. In other words, a cyclical
• Economic DepressionEconomic DepressionAn economic depression is an occurrence wherein an economy is in a state of financial turmoil, often the result of a period of negative activity based on the country’s Gross Domestic Product (GDP) rate. It is a lot worse than a recession, with GDP falling significantly, and usually lasts for many years.
• The Economic Crash of 2020The Economic Crash of 2020The economic crash of 2020 was precipitated by the COVID-19 pandemic. The sudden appearance of the virus, its rapid spread, and uncertainty about how
• VIXVIXThe Chicago Board Options Exchange (CBOE) created the VIX (CBOE Volatility Index) to measure the 30-day expected volatility of the US stock market, sometimes called the "fear index". The VIX is based on the prices of options on the S&P 500 Index