Defensive stocks are the stocks that provide the investors with a constant and stable dividend, regardless of the stock market condition. These stocks, commonly, stay stable in every business cycle due to the constant demand for its products.
Many people tend to confuse defensive stocks with defense stock that refer to the stocks of companies producing stuff like ammunition, fighter jets, and weapons.
Defining Defensive Stocks
This type of stock has the tendency to perform better than most of the other assets during the recession. On the other hand, in an expansion phase, these stocks tend to perform behind the other asset.
That comes from the low beta or relative risk and performance within the market. Most of the defensive stocks only have betas less than 1.
Usually, investors will invest in low beta stocks in a market downturn. Once the market is going to prosper, active investors will turn into stocks with higher betas since they want to maximize their return.
Examples of Defensive
Many investors use this term to refer to “non-cyclical stocks” because they do not have a big dependency on the business cycle. The example of this type of stock ranges from utilities, consumer staples, health care stocks, to apartment REITs.
The Effect on Your Portfolio
Having these stocks within the portfolio, protect many investors from the weakening economy or periods of high volatility. Big and well-established companies like Johnson & Johnson, Phillip Morris International, and Coca – Cola are the example of defensive stock.
These are the companies that will provide investors with strong cash flows and have strong operations. Besides those, these companies also pay dividends that may create stock price cushion in a market decline.
Many people question why choosing stock over the safety of government bonds during the shaky economy. The answer to that is that fear and greed mostly drive the market.
Thus, defensive stocks facilitate that greed by providing higher dividend yield in a low-interest-rate environment. At the same time, these stocks also alleviate fear since they are not as risky as regular stocks. Besides, during that bad economic situation, many investment managers have no choice than owning stocks. Once the situation getting rougher, they mostly will migrate to defensive stocks.