Defensive stocks represent stocks of companies that tend to perform well even during economic downturns or when the market is volatile. They run in contrast with cyclical stocks and other types of stocks such as growth stocks and value stocks because they are less susceptible to the cyclical fluctuations of the economy while remaining stable and reliable regardless of the economic and market conditions. This article lists and describes the notable characteristics of defensive stocks and provides tips on how and when to pick them.
Key Characteristics of Defensive Stocks
Determining the Right Stocks that Remain Stable Regardless of the Condition of the Economy and Market
Purchasing and holding defensive stocks have several advantages. These include portfolio diversification and ensuring your entire portfolio remains afloat during downturns. These stocks also minimize the risks of stock investing while highlighting the advantages of participating in the stock market. The following are their specific characteristics:
• Stable and Reliable: Companies in defensive sectors and industries often have stable earnings even during an economic recession or when the general stock market and stock indices are volatile. The stocks that they issue also remain reliable with little to no downward movement in their stock prices.
• Defensive Companies: Note that companies that issue defensive stocks are also called defensive companies. They operate in the utilities, energy, health care, and consumer staples sectors and industries. Specific examples include telecommunication services providers, oil and gas companies, and pharmaceuticals, among others.
• Established Branding: These so-called defensive companies have a strong brand and company reputation. They are often leaders in their respective sectors, industries, or markets with a strong competitive advantage. Their brands are also household names or have a high degree of recognition and recall.
• Has Low Beta: Another notable characteristic of defensive stocks is that they have a low beta. Note that the beta is the measure of the historical volatility of a particular stock in comparison with the stock market index. Stocks with low beta means that they are less volatile compared to other types of stocks in the stock market.
• High Dividend Yield: Some defensive stocks are dividend-paying stocks or are issued as preferred stocks. These stocks tend to have higher dividend yields compared to other preferred stocks. Their consistently high payout means that their historical earnings remain consistent or stable regardless of the economic and market condition.
• Low-Debt-Equity: The debt-to-equity ratio of these stocks is low. Note that this financial ratio can help in evaluating the leverage of a particular company. It is calculated by dividing its total liabilities by its shareholder equity. A low debt-to-equity ratio means that a company has more owned capital than borrowed capital.
• Non-Cyclical Stocks: Another important characteristic of defensive stocks is that they are a complete opposite of cyclical stocks. They also have some differences with growth stocks and value stocks but they can also share some characteristics. Some of these stocks can also be mid-cap stocks or large-cap stocks.
Important Tips and Reminders for Choosing the Right Defensive Stocks to Add to Your Investment Portfolio
Defensive stocks are also a type of defensive assets or instruments. Investing in them can be part of a defensive investment strategy that aims to preserve wealth while generating enough returns to outpace inflation. Doing so is also an integral part of portfolio diversification. The following are tips and reminders for spotting and investing in these stocks:
• Ask Yourself Relevant Investment Questions: It is important to understand the reason behind your investment decision and ask yourself essential investment questions that will help you understand your specific purpose, the type of investment you will be choosing, and your risk tolerance, among others. Remember that investing in defensive stocks is a wealth preservation strategy.
• Invest in Recession-Proof Sectors and Industries: Remember that these stocks are concentrated in specific sectors and industries that tend to perform well or remain stable even during an economic downturn or slumps in the stock market and the overall financial markets. Companies in these sectors or industries produce or provide essential goods and services.
• Analyze the Financial Health of Companies: Another important tip to spot defensive stocks is to check the financial health of issuing companies. Their earnings should be stable based on historical data and especially during poor economic or market conditions. They have a low debt-to-equity ratio and their cash flows are strong enough to weather economic downturns or market volatility.
• Check For Consistent Dividend Payouts: Remember that one of the characteristics of defensive stocks is their high dividend yield. Their payouts are also consistent according to historical payout schedules. This is an indicator that their earnings remain profitable and that their cash flows are stable or consistent. Stronger defensive stocks also have dividend yields that increase over time.
• Evaluate the Competitive Position: It is also important to evaluate the competitive positions of prospective companies. Look for companies with strong brands, company reputation, and market leadership. These companies produce or provide goods and services that have unique selling points and established distribution channels. They also have a strong competitive advantage.
• Prioritize Protection First Before Growth: One of the principles of a defensive investment strategy is to prioritize protection first and growth second. Protection or preservation means that your principal or initial amount invested remains intact. Investing in defensive stocks means that your utmost purpose is to preserve your wealth or capital while remaining hopeful for wealth accumulation.