A defensive stock refers to a stock that offers a constant dividend and stable profits. They are called defensive stocks because they provide those mentioned benefits regardless of the condition of the overall stock market.
There is a constant demand for their products, these defensive stocks usually remain stable during the different phases of the business cycle.
Defensive Stocks for Investors
Defensive stocks typically outperform the broader market in times of market downturn or recessions. On the other hand, during the expansion phase, they usually perform below the market average.
The strength of the defensive stocks has something to do with their low beta, which is their relative risk or performance to the market.
Investors like to invest in low-beta, defensive stock when they expect a market downturn is expected to happen.
On the flipside, when the market is expected to run bullish, active investors often select stocks with higher betas in hopes of maximizing the returns.
Some examples of defensive stocks include water, gas, and utilities because people need them and people will always buy them during all business cycle phases.
Utility companies are also thought of as benefiting from slower economic environments because the interest rates are usually lower and their competition to borrow funds is much lower.
Companies that manufacture or distribute consumer staples, which are products that consumers tend to buy out of necessity regardless of economic conditions, are also largely considered as defensive stocks.
They include food, hygiene products, tobacco, beverages, and certain household items. These businesses have steady cash flow and predictable earnings in times of strong and weak economies.
And because of that, their stocks usually outperform non-defensive or consumer cyclical stocks. These products, however, underperform non-defensive stocks during strong economies.
Heath Care Stocks
Historically, the market has considered the stocks of major pharmaceutical companies and medical devices manufacturers as defensive stocks. The logic is simple: no matter what the phase of the economic cycle is, there will always be sick people.
However, because of the higher competition from new branded and generic drugs, as well as the uncertainties that surround drug price regulation, these health care stocks are not as defensive as they have been once.
Apartment Real Estate Investment Trusts
Apartment REITs are also considered defensive. As you may guess, people will always need homes and shelters.
Additionally, REITs are required to pay at least 90% of their taxable income in the form of shareholder dividends every year.
When searching for defensive stocks, stay away from REITs that mainly invest in ultra-high-end apartments, as well as office buildings REITs and industrial parks REITs. These could see defaults on leases when the economic is not doing well.
Why Invest in Defensive Stocks
Investors who want to protect their portfolios during an economic downturn or times of high volatility may increase their exposure to defensive stocks.
Apart from the steady cash flows, these companies sport strong operations with the ability to survive weakening economic conditions.
Most of them also pay dividends, which can have a protective, cushioning a stock’s price during a market downturn.