What are Defensive Stocks?
Defensive stocks are those stocks that provide constant dividends and stable earnings regardless of how good or bad the market is performing. These stocks have constant demand in the market, and due to this, they remain stable during the various phases of the business cycle.
Remember: Do not get confused with the Defence stock companies which are into weapon and ammunition manufacturing.
These stocks are a good bet for the long term as they give consistent dividends and stable earnings and can help you grow a huge wealth.
These stocks are considered to have a high Sharpe ratio. These stocks have low risk thereby protecting you from losses. They can be the best bet for those investors who are looking for safe bets in long term.
Due to low volatilty of these stocks the chances of getting high returns also reduces. They give less profit even during the bull run. These stocks can also underperform when you realy expect them to perform in the bull markets.
Industries covered by defensive stocks:
- Consumer goods: Companies producing or distributing consumer goods usually fall in the category of defensive stocks. Consumer goods include food, beverages, certain household items, tobacco, hygiene products, etc. These are day to day use items that have a certain cash flow at all economic conditions. So, these stocks outperform during weak economic conditions and underperform during strong economic conditions when compared with cyclical stocks.
- Healthcare Stocks: Major pharmaceutical companies and manufacturers of medical devices are considered to be defensive stocks because medical aid is required irrespective of the economic condition. But now with an increase in competition from new branded and generic drugs these stocks have become less defensive.
- Utilities: Utilities such as water, gas and electricity are basic requirements of livelihood. So, the demand remains the same at all phases of the economy and thus are least affected by the market changes. Further utility companies draw benefits at the time of recession as they get borrowings at lower interest rates with minimal competition.
Now as you have understood the meaning of defensive stocks, you may think why to choose defensive stocks over risk-free investment options? During the downfall of the market, why to even invest in a stock when you can invest in treasury bills and other safe investment options? Yes, it’s absolutely right to choose safe investment options during the downfall of the market. But just a chance to earn dividend at a higher rate than that of interest on treasury bills with less risk attracts investors towards defensive stocks.
As an investor, you should take calculated amounts of risks so that you can go through the hard times and enjoy the benefits. Proper knowledge and understanding of the market and stocks before investing will help you fetch better returns.