Defensive industries comprise businesses that are relatively stable or relatively immune to economic fluctuations, i.e., economic expansions and recessions. Defensive businesses remain relatively unaffected in the event of an economic boom or recession in the sense that their earnings are uninfluenced by the economic fluctuations. The industry usually consists of businesses dealing in necessity goods, i.e., essentials, in the market.
Characteristics of Defensive Industries
1. Resilient to economic fluctuations
As mentioned earlier, because defensive industries comprise businesses that usually deal with necessity goods or essentials, they are relatively resilient to economic boom periods or recessions. Due to such fact, defensive industries are able to survive the worst economic downturns.
2. Deals with necessity goods
Defensive industries comprise of businesses usually dealing with necessity goods. It is because necessity goods are regarded as essentials by a consumer. Hence, their elasticity of demand is relatively inelastic. It implies that regardless of the changes in income, price of related goods, etc., consumers will purchase the necessity goods.
3. As resilient to economic expansions as they are to economic recessions
Defensive industries are as resilient to economic expansions or boom periods as they are to economic recessions. Since defensive businesses only deal with necessity goods, consumers only deal with them to the extent of their necessity.
Hence, during expansion periods, when the economy is flourishing and there are large inflows of cash, consumers will not end up spending the extra cash inflow on necessity goods. They will do so only to the extent of the good’s necessity. Hence, defensive industries are relatively stable during expansions as they are during recessions.
4. An attractive option for investors
Defensive industries are a very attractive option for investors, especially during an economic downturn. It is because they are able to survive a recession better than other industries. Hence, during recessions, defensive industries attract the most investors and are regarded as a lucrative investment opportunity.
5. High stability, less volatility
Another reason why defensive industries are considered a safe haven for investors is that defensive businesses are less volatile compared to other industries. Hence, especially for investors who are not big risk-takers, defensive stocks are considered a safe haven owing to the stability and insignificant volatility associated with them.
6. Long-term returns
Owing to the stability of defensive industries, they usually are an attractive option for investors because of the substantial returns that they provide in the long term.
7. Job security
Defensive industries are highly sought after in the labor market because of the job security that the businesses offer. During economic recessions, many businesses fail to generate revenue as expected, and hence employees end up losing jobs when the businesses try to cut back on their expenses. Since defensive industries are relatively stable during recessions, job security associated with the industry is high.
Necessities are normal goods that are treated as essentials by consumers. As the goods are a necessity in every consumer household, the consumer will buy the good regardless of the changes in factors affecting its demand. Hence, regardless of the changes in price, personal income, price of related goods, etc., the consumer will purchase essential goods.
A few examples of necessity goods are food items that are a staple to a consumer market, like wheat and rice in Asia; utilities like electricity, basic transportation like public transport, and so on. The price elasticity of demand for a necessity good is relatively inelastic. Similarly, the income elasticity of demand for necessity goods is also relatively inelastic. It implies consumers will purchase necessity goods regardless of changes in their income.
Company Examples – Defensive Stocks
Defensive stocks represent investment options from defensive industries. Hence, businesses that fall under defensive industries are regarded as defensive stocks in the investment sector. The most sought after defensive stocks are healthcare companies, discount retailers and utility companies.
1. Healthcare Companies: Johnson and Johnson
Johnson and Johnson (NYSE: JNJ) is a multinational company that develops medical devices, pharmaceuticals, and consumer packaged goods. During the recession, the Dow Jones Industrial Average fell 53% from the end of 2007 to mid-2009. At the same time, Johnson and Johnson’s stock price only dropped by 33%, outperforming the market by about 20%. It also outperformed every recession in recent history.
2. Discount Retailers: Walmart
Walmart (NYSE: WMT) is a giant retail company that operates a series of grocery stores, discount department stores, and hypermarkets. Known as a discount retailer, Walmart provides relatively cheap products to its consumers through its large economies of scale. During the 2008 recession, Walmart’s net income was increasing due to stable demand from consumers. Looking at changes in its stock price during the economic downturn, Walmart outperformed the Dow Jones index by 43%, falling only 10%.
3. Utility Companies
Pacific Gas and Electric Company (NYSE: PCG) provides natural gas and electricity in California and is one of the United State’s biggest utility providers. It only dropped by 42% during the 2008 recession, outperforming the Dow Jones by 11%.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below: