What are Defensive Stocks?

The stock market can be volatile, which means investors may see their earnings go up and down. For this reason, some investors put their money in securities that offer more stable returns irrespective of how the market is performing. Defensive stocks are an example of an investment that can offer consistent returns. This type of stock usually gives investors consistent dividends irrespective of how the market is doing and can be especially attractive in bear markets.

What Are Defensive Stocks

The primary characteristic of a defensive stock is that it’s not impacted by market swings. Unlike cyclical stocks, they can usually withstand any market condition. This can be beneficial when the market isn’t performing well, but also means investors can’t take advantage of high returns during periods of high economic growth.

Defensive stocks are notorious for having low beta, which is about how a stock’s price changes relative to market movement. In terms of score, defensive stocks have a beta of below 1, meaning they aren’t as volatile in comparison to the broader market like the S&P 500, for instance.

Defensive stocks are prominent in non-cyclical industries or ones that have consistent demand. Examples of defensive markets include healthcare, utilities, and consumer staples. They tend to be resilient markets as they meet core daily needs of consumers.

How Defensive Stocks Work

A good time to invest in defensive stocks may be when you anticipate a market downturn. It’s also possible to invest in them at any other time to balance out a portfolio and guard against downturns. With this in mind, the quantity of defensive stock in a portfolio hinges on an investor’s short and long term goals.

Defensive stocks can especially be helpful for investors who rely on income from dividends. The income is usually steady and predictable, which can create a form of stable income. The income from dividend stocks can also help when saving towards a financial goal.

There are multiple factors to consider before investing in defensive stocks and three include dividends, balance sheets, and valuation.

• Dividends: As mentioned, consistent dividends are a key aspect of defensive stock. In order for a company to pay dividends in every market condition, they must have achieved positive earnings and cash flow over extended periods. Do research to ensure the dividends stocks you’re buying are from companies with a solid history of consistent dividend payments.
• Balance sheet: A balance sheet records a company’s assets, liabilities, and shareholder assets. Defensive stocks usually have conservative balance sheets, so investors should interrogate companies with unusually high dividend yields. It could indicate the company has copious amounts of debt they took out to pay those dividends. It could also mean a company is issuing excessive shares to cover the cost of these dividends, which can dilute the share value over time.
• Valuation: When investing in defensive stocks, pay attention to the stock’s valuation. Although defensive stocks can sometimes be on the lower end of the spectrum when it comes to price, they may still be overvalued. Before investing in a defensive stock, do a thorough analysis to make an informed investment decision.

Downsides of Defensive Stocks

These types of stock are generally safe investments with conservative returns. As the saying goes, lower risk comes with lower rewards, especially during bull markets. Defensive stocks may even perform below the market during these periods.

Another potential downside of defensive stocks is they may be risky to trade when markets are down. While holding them can be beneficial because of the dividend payments, in turbulent markets they can easily become overvalued. This can happen during times of economic downturn when the demand for them goes up and share prices rise consequently. Also, when interest rates are high, demand may fall as investors could turn to more favorable investments like bonds or CDs.

If you’re unsure about whether to invest in defensive stocks, speak to a financial advisor.