Prior to making any investment decisions, it is essential for investors to identify their priorities, their risk potential and to have a clear understanding of the businesses they want to invest in. The reason for investment varies among individuals and therefore the avenue for investment also differs. There are 2 types of stocks namely cyclical and defensive; let’s have a good view of what defensive stocks are and how investors can benefit from investing in these stocks.
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What is Defensive Stock?
Defensive stocks, as the title indicates, protect an investment portfolio from losses. Also referred to as non-cyclical stock, they offer stable earnings, irrespective of market conditions. Although they do not provide a tremendous opportunity for growth, they continue to do so even through times of economic recession, when most equities are declining. Such stocks can eliminate a significant loss of value to the investment during an economic downturn or a bear market.
Characteristics of Defensive Stock:
- Stocks of businesses that are into necessity goods like FMCG, healthcare, utilities, etc are defensive stocks.
- They have a beta lower than one.
- They generate lower returns.
- In a financial meltdown, these stocks will safeguard a portfolio.
- Defensive stocks provide regular dividends.
- Beta is the stock’s vulnerability or risk factor. Since they have a beta lower than 1 which indicates that they are less volatile.
Investing in Defensive stock:
Investors looking to secure their portfolio, during an economic slowdown or times of high volatility, could increase their exposure to defensive stocks. Mature companies like Proctor & Gamble, Coca-cola, etc are considered defensive stocks. These companies have a strong cash flow and smooth operations and can survive weakening economic conditions. Warren Buffett who is one of the greatest investors of all time became so by focusing on defensive stocks.
- Utilities: Utilities are one of the most common defensive stocks. Regardless of the economic state, people still need electricity, water, and gas. Therefore, investors can use utilities to protect their investments from substantial losses if an economy seems to be entering a recession. For example, Tata Power, Adani Power, BF Utilities, etc.
- Consumer goods: Consumer goods specifically non-cyclical consumer goods are consumed by people regardless of how markets are performing. These stocks include hygiene items like soaps, shampoos, and toothpaste, basic foods like bread and milk, etc. for example, Colgate-Palmolive, Mondelez.
- Healthcare: Healthcare is another sector that will never go out of demand. These stocks include pharmaceutical firms that supply and run institutions such as hospitals, clinics, etc., manufacturing OTC medications and medicines and healthcare services. For example, Johnson & Johnson, Pfizer, Philips healthcare, etc.
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Defensive stocks are those stocks that are consistent regardless of the state of the market. Ultimately, these stocks are only one of the numerous investment measures that can be used in the portfolio to reduce risk. They are the opposite of Cyclical stocks which flow according to the economic cycle. A conservative investor who is afraid of taking risks can invest in defensive stocks that will give stable returns even during the recession.
Author – Abha Shetty
About the author – Abha is a second-year BMS student and FRM level 1 candidate. She is very intrigued by the world of financial markets and hopes to master the art of investing and trading.