What are Defensive Stocks? Definition & Examples

Counter-cyclical stocks usually outperform the market during economic downturns and can underperform during periods of economic growth, when other stocks are doing well. On the other hand, defensive stocks tend to perform consistently throughout all stages of the business cycle. The opposite of a defensive stock would be a cyclical stock, which tends to see price fluctuations based on different phases of an economic or business cycle. For example, cyclical stocks perform better during periods of economic growth and rising inflation, when consumer have more disposable income to spend on products and services that aren’t deemed necessary. During a recession or a bear market, however, these types of stocks would typically fall in value, having a knock-on effect on their share price.

Conducting a thorough analysis of the stock’s valuation can help investors make informed decisions and avoid overpaying for their investments. Our experts choose the best products and services to help make smart decisions with your money (here’s how). In some cases, we receive a commission from our partners; however, our opinions are our own. While utilities are often considered to be a sleepy part of the market, there’s been nothing sluggish about their performance this year.

Defensive FTSE 100 stocks in the UK

The margin of safety is the idea of purchasing the security at a substantial discount to its true value, which is supposed to offer the potential for large returns while simultaneously lowering negative risk. Healthcare is a necessity, and there is always a need for drugs and medical supplies; thus, this industry presents excellent defensive investment prospects. The electric, gas, and water utilities, as well as businesses that function as distributors or producers of those utilities, are all included in the utility sector. Benjamin Graham, Warren Buffett, and Charlie Munger, all-time greats, all talk about having conviction in your investments and buying companies with a margin of safety and moats.

Simmons says that one portfolio holding that has illustrated these investment themes is NextEra Energy Inc. (), a major US electricity utility that has been working toward decarbonization of its operations. The company recently announced its revenues were up 18% year-over-year in U.S. dollars, and up 21% in constant currency, to $12.4 billion. Moreover, the company is extremely profitable and pays a hefty dividend – especially for a tech stock – along with share buybacks. The company generated $62.1 billion in free cash flow after all its capex spending. Exxon Mobil (XOM, $103.41) is one of the biggest oil and gas companies in the world, with revenues last year over $400 billion ($413.7 billion), up almost 45% from 2021 ($285.6 billion).

Disadvantages of Defensive Stocks

These companies are often at the forefront of many scientific and technological developments, and always have a consistent customer base. Given the interest rate increases and the expected economic slowdown in 2023, the S&P 500 has declined 17.5% year to date and the NASDAQ has declined 30.6% year to date. Yet there’s also a compelling longer-term case to be made for the sector, he says. In addition, Coca-Cola says it is gaining market share in the nonalcoholic ready-to-drink (“NARTD”) beverages segments. In 2022, Coca-Cola’s sales were up 11% to $43 billion, and on a non-GAAP “organic” basis, they grew 16%.

Many of the same defensive stocks have also raised their annual dividends for many consecutive years. For one thing, the sector faces much less earnings risk than other parts of the market, he says. Consumers and businesses are likely to continue to spend on utilities even if there’s an economic downturn. The companies tend to hold up well in response to inflationary pressures, because they pass higher costs straight through to customers. And as domestic businesses, they don’t face the headwinds of a strong dollar that many other sectors currently face. Given its solid revenue growth, operating margins, free cash flow, dividends and buybacks, Oracle stock looks like one of the best defensive stocks to buy right now.

defensive sectors

Defensive stock investing can often be less dangerous than cyclical stock investing. Any form of investing carries risk, including the potential for financial loss. On the other hand, defensive stocks are less likely to experience a value decline during a stock market downturn or a recession because their products and services remain continually in demand. For this reason, defensive stocks are often seen as a type of ‘safe haven asset​​’ which investors may buy and hold as a way to hedge against portfolio risk. Companies in these sectors cater to people’s basic needs, providing goods and services that are in constant and consistent demand.

In the end, a defensive stock is any stock that performs consistently regardless of changes in the market. Healthcare is something people need regardless of how well the stock market is doing. This makes the sector a staple of defensive stocks, and McKesson is a great example. The company provides a range of services in healthcare supply chain management, specialty care, retail pharmacy and more. Defensive stocks are nearly always in demand because they provide essential products and services while cyclical stocks are affected by consumer demand and systemic changes like market downturns. Utilities, consumer staples, and healthcare represent the main defensive sectors.

While the Dow Jones Industrial Average (DJIA), S&P 500, and Nasdaq plunge throughout the pandemic, defensive stocks become a safe haven for fearful investors. For investors who do not know much about the stock market, defensive stocks are a good option to start out. They allow investors to get a feel for the market first without requiring them to burn through their capital with more aggressive stocks.

Telecommunication Services

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Investors will likely still turn to defensive stocks to protect their portfolios. By contrast, if you spread your money among funds in the healthcare, consumer staples, utilities, and telecommunications sectors, you can enjoy greater diversification. In turn, you would reduce—but not eliminate—the amount of loss you might experience in your portfolio if one defensive industry were to decline.

What are the advantages of investing in defensive stocks?

Water, electric, gas and broadband supply utilities are examples of defensive stocks because we all still need them during all economic cycles. The team at Stocks Down Under have been in the markets since the mid-90s and we have gone through many earnings seasons. We have seen many ups and downs and analysed https://forexarticles.net/best-50-freelance-programming-sites-in-2021/ stocks and management teams in every sector over the years, including many defensive stocks. Companies with a beta of less than one are less volatile than the market and tend to be defensive stocks. On the other hand, companies with a beta that is greater than one are more volatile than the market.

• One of the main disadvantages of defensive stocks is that they tend to have a lower potential for capital appreciation compared to more volatile investments.
• We then personalize it based on your goals and preferences resulting in a custom-tailored portfolio just for you.
• AllianceBernstein Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom.
• For example, even if FCF drops by 20% over the year, it still means Exxon will produce at least $50 billion in FCF throughout 2022.
• It creates upwards of 100 new inventions annually for customers in more than 100 countries.

These failed attempts at market timing using defensive stocks can significantly lower the rate of return for investors. Defensive stocks offer the substantial benefit of similar long-term gains with lower risk than other stocks. Defensive stocks as a group have a higher Sharpe ratio than the stock market as a whole. That is a strong argument that defensive stocks are objectively better investments than other stocks.

Personal Investment Services

The sector underperformed the broad market during the inflationary downturns of the 1970s (though subsequently outperformed), so he is circumspect about pounding the table. Typically, these defensive companies generate a sufficient amount of free cash flow (FCF) that can support both dividend payments and also stock buybacks. FCF is the amount of cash flow that exceeds all the company’s cash expenses (not including depreciation and amortization, for example). In addition, FCF covers the company’s capital expenditure needs like new plant and equipment purchases, as well as working capital spending. What’s left is “free” to be spent on dividends, buybacks, debt reduction, acquisitions of companies and cash accumulation.

• When investors suspect that the economy is headed for a decline, many begin to pad their portfolios with defensive sector funds.
• Investing in defensive stocks may lower your overall risk as part of a diversified portfolio.
• It’s possible that rising unemployment is putting additional pressure on many already struggling retail tenants.
• That is quite an achievement, and is likely one reason why KO is one of Warren Buffett’s favorite stocks.
• Since these companies are typically found in non-cyclical industries with stable demand, they may not have as many opportunities for growth as companies in more volatile sectors.

Let’s take a look at each, and an example of a leading company in the industry. You can also learn more about sector investing and read more recent market insights and commentary from Fidelity’s portfolio managers. He’s been looking for companies that may hold up best, within the sector, under the combined pressures of a softening economy and rising input prices. It makes intuitive sense that companies in the consumer staples sector—which can encompass everything from bread to bacon, and toilet paper to toothpaste—generally hold up well in a rocky economy. We all still need to brush our teeth and eat breakfast in the morning, no matter what the market is doing.