What Are Defensive Stocks?

There are many challenges that investors face to continually turn a profit. Moreover, investors generally do not only aim to profit but to profit enough that they beat the market. However, what happens when the overall stock market is underperforming? Is there anything that can be done? Are there “safe stocks…?” While no stock is foolproof — and every investment made is also a risk being taken — there are some stocks that are safer than others during market downturns. In fact, these stocks are often referred to as “defensive stocks.” Typically, a stock is considered a defensive stock when it provides constant dividends and stable earnings no matter what the state of the overall stock market is. Further, this is often the case when a company can achieve a constant demand for their products or services throughout all economic climates.

Although there are many different ways to describe economic climates, we will stick to recessions and expansion phases for the sake of simplicity. As mentioned above, defensive stocks tend to outperform the market during downturns. Conversely, though, defensive stocks often do not perform as well as the market during phases of expansion. Why is this? In order to explain, investors can look towards a defensive stock’s beta — which is usually less than one. As a quick refresher, beta is most commonly defined as a measure of the volatility, or systematic risk, of a stock in comparison to the market as a whole. For example, a stock with a beta of 1 will undergo price movements that match those of the market. Moreover, a stock with a beta greater than 1 will display higher levels of volatility than the market — if a stock has a beta of 1.5, it is hypothetically 50% more volatile than the market. On the other hand, if a stock has a beta of 0.5, it can be expected to underperform the market by 50% during an expansion phase, but beat the market by 50% during a recession. Accordingly, this is consistent with the nature of defensive stocks.

Now that you understand what a defensive stock is, let’s go over a few examples. A great place to start is in industries that tend to be relatively inelastic. By inelastic, I am referring to how the demand for the specific industry responds to price changes. For instance, the utility industry is commonly considered a good place to start because, during any phase of the market cycle, people need access to gas and electricity. Other sectors (or industries) that are frequently considered to be defensive are pharmaceuticals, healthcare, food, and beverage companies. Another great example is large tobacco companies, especially back when the number of smokers in the United States was much higher, because of how addictive their products are. Essentially, their sales are extremely inelastic since addicts are willing to spend what they must in order to fulfill their needs and market trends do not affect it. Additionally, some investors consider particularly large blue chip stocks like Walmart or Procter & Gamble Co. to be defensive as well — also referring to them as non-cyclical stocks. Companies such as these are simply so expansive that they will likely still have positive sales figures even when the overall market is not performing well.

As an investor, it is almost always a good idea to consider new ways to diversify your portfolio. Whether is it by exploring different investment options such as ETFs and bonds, or, trying out a new strategy, great investors are constantly looking for different ways to become better. Who knows? Maybe including defensive stocks into your strategy is just want you need to round out your portfolio. Ultimately, conducting research and doing your own due diligence is the only way to find out!