One of the main reasons for stock traders to invest in defensive stocks is as a defensive measure against economic uncertainty.
These companies are so-called because they tend to be less volatile and more stable than the wider market, even in times of economic turmoil.
In this blog, we’ll outline what makes a stock defensive, how to recognize which shares are defensive, and why you might want to include them in your portfolio.
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What is a Defensive Stock?
A defensive stock is expected to maintain a stable share price during an economic downturn or when the broader market falls.
Typically these are companies with products or services that people will continue to buy regardless of how much they spend.
How Do You Identify Defensive Stocks in the Indian Stock Market?
Typically, defensive stocks have the following characteristics:
- They are low-growth businesses but generate stable cash flow from operations.
- They have stable and predictable earnings growth, usually in the single digits.
- They pay out a large portion of their earnings as dividends.
As a result, investors typically turn to defensive stocks to reduce risk in their portfolios, especially during uncertain times in the market cycle.
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Defensive Stocks Have the Following Characteristics:
Stable Revenue and Earnings Growth: Defensive stocks have steady revenue and earnings growth which means they don’t make large profits or losses in any particular year.
Low Debt: Most defensive stocks have very little debt. Debt is not something these companies would want to carry on their books as it affects their valuation.
High-Profit Margin: Defensive Stocks also tend to have high-profit margins, compared to other sectors, because of the stability in their businesses. This high-profit margin keeps them profitable during economic downturns.
Stable Dividends: The dividend payment for most defensive stocks is stable and growing steadily over some time.
These dividend payments are also less volatile than consumer discretionary or technology stocks.
Advantages of Defensive Stocks in India
Defensive stocks are companies that sell products and services that are considered essential and non-cyclical.
These products are not affected by economic downturns and always remain in demand.
For example, a company that sells FMCG products like soap, toothpaste, shampoo etc., or a pharmaceutical company can be considered as a defensive stock.
The recession affects the demand for these products because people still need to buy food, medicines, and other items for daily use.
Defensive stocks generally have competitive advantages like low-interest rate loans, government contracts etc.
These stocks tend to be less volatile than cyclical stocks and provide a greater level of security to investors. Defensive stocks also offer higher dividend yields.
Why Defensive stocks are suitable for your Portfolio
Defensive stocks are those which can weather economic downturns and market volatility.
These stocks can provide stability to your portfolio, and hence they are known as defensive stocks.
The characteristics of defensive stocks include stable or consistent earnings, regular dividend payouts, low beta, lower risk profile and low volatility.
Defensive stocks belong to sectors with essential products or services and are used in all phases of the economic cycle.
So, when the economy is weak or during periods of uncertainty, these stocks perform relatively well compared to the overall market.
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Industries Come under Defensive Stocks
Electric utilities, water, and gas are examples of defensive stocks. Similarly, communications service companies such as telephone and cable television companies are also defensive.
Since utility companies primarily deal in essential services and communication, these businesses remain fairly stable during recessions.
Pharmaceutical companies are another example of defensive stocks. These companies generate revenue by selling drugs that treat chronic conditions like high blood pressure, diabetes, and arthritis.
Although some prescription drug sales may decrease during a downturn due to patients’ inability to afford them, new customers will enter the market.
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Consumer staples are non-discretionary products that people buy regardless of income levels or economic cycles.
For example, consumers still need food and personal care items even during economic downturns.
Consumer staple stocks are also considered defensive because they offer stable earnings with modest growth prospects;
These qualities make them appealing to conservative investors seeking low-risk equities.
Food stocks are a great example of defensive stocks. Food items like rice and wheat are in high demand regardless of the economic conditions.
When the economy is booming, people buy more food products, but even when the economy is struggling, they still buy basic food items like wheat and rice.
Defensive stocks are a must-have in every investor’s Portfolio. They help to create a balanced portfolio and reduce overall risk.
Defensive stocks are not affected by economic downturns and hence, their value does not decrease much in bearish market conditions. These stocks are ideal for investors who want to create a diversified portfolio.