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Defensive Stock

A stock that shows a relatively stable performance regardless of the current state of the economy

What is a Defensive Stock?

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 cycle of expansions and recessions. Defensive stocks will come with a steady dividend payment and a more constant share price.

 

Defensive Stock

 

During an expected recession, 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 services 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-averse 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 markets, 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

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

  • Cyclical Industry
  • Economic Depression
  • The Economic Crash of 2020
  • VIX

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