Learn What is a Defensive Stock

Defensive Stock Meaning: A defensive stock is a stock that gives consistent returns to its shareholders in the form of dividends, regardless of the stock market’s overall performance. Defensive stocks can generate stable earnings in good and bad economic cycles. It is because the nature of the underlying business is such that people are constantly consuming their products. FMCG, utilities, retail, and personal care stock fall under defensive stocks.  

The defensive share also traditionally comes from several sectors that have one thing in common: they produce necessities or consumable products essential for daily usage.  For instance, if a company manufactures and sells a product like toothpaste or eatables. People will consume such products no matter what the situation is. They will have to spend on food to fill their stomachs. People may avoid purchasing a car or an air conditioner. However, no one will stop brushing their teeth or stop eating snacks, so they will successfully generate good earnings. You must have understood the defensive stocks definition; let’s discuss the advantages of defensive stocks. 

Advantages of Defensive Stocks

Because these stocks provide consistent dividends and generate stable earnings, investors tend to hold onto these stocks. Sometimes, the underlying company may be sitting on too much surplus cash to give its shareholders multiple dividends in a single financial year. It is why defensive stocks are less volatile than cyclical and growth stocks. As a result, they have a lower beta value than the overall market. 

During market corrections, the stock price of defensive stocks shows only a minor correction. At times, they may even remain unaffected. 

During economic crises or downturns, growth stocks and cyclical stocks may plummet. But, at the same time, defensive stocks may still manage to hold their ground relative to other stocks. 

It also makes them a less risky investment option when compared to cyclical and growth stocks. These stocks tend to have a Sharp Ratio, which is higher than indices like the Nifty 50 or the Sensex. Investors don’t need to take a high risk to beat the market. Good defensive stocks are very capable of beating the market. 

The gradual increase in their earnings can reflect the stock price. Defensive stocks of established companies can even combat high inflation to an extent. Their brand value gives them high pricing power. And due to the nature of their business, people will continue to purchase their products despite the price increase. 

Disadvantages of Defensive Stocks

However, investing in defensive stocks has its fair share of downsides. Or else, every investor would pump their money into defensive stocks. Due to their lower volatility or low beta values, the stock price of these stocks may underperform during a bull market. The price may never plummet, but at the same time, it will even shoot up at a fast pace. A significant reason a defensive stock’s stock price barely rallies is that the underlying company is unlikely to show high earnings growth. 

During an economic boom, people do not buy more of the company’s products. Their purchases will remain more or less the same. This is because the company’s balance sheet will exhibit similar earnings or a small earnings growth. At the same time, a cyclical company will exhibit high earnings growth. People will not buy extra soaps or toothpaste because the employment rates are high. Instead, people will buy cars and other premium goods. 

Industries covered by Defensive Stocks

Stocks belonging to the following industries fall under the category of defensive stocks.

Fast Moving Consumer Goods

The FMCG or Fast moving consumer goods industry is the most popular industry to have defensive stocks. These industries sell foods and beverages like instant noodles and pasta, milk, colas, baby formula, and chocolates. 

The industry includes personal care products like soaps, shampoos, and toothpaste. Tobacco and alcohol also come under the label of FMCG. 

Retail

The consumer retail industry also acts as a proxy to the FMCG industry as most products they sell fall under the FMCG category. Hence consumer retail stocks may also portray defensive characteristics.

Utilities

Utilities like gas and electricity stocks are essential requirements for a sustainable livelihood. So power and gas stocks are also not affected during market corrections or economic downturns, as people continue to consume and pay for their gas and electricity supply. 

Role of Defensive Stock in a Portfolio

One of the primary roles of a defensive stock is to preserve one’s capital. Defensive stocks provide relief to investors during periods of high uncertainty and volatility in the stock market. They save the investor’s portfolio from crashing during a recession in the economy or a global crisis. Defensive stocks also act as a hedge to cyclical and growth stocks. They help offset the losses a cyclical or growth stock may incur during a bear market. However, good defensive stocks can deliver steady returns to their shareholders. They are very capable of outperforming the more significant market as well. 

Reasons To Invest In This Type Of Security

Here are the different reasons to invest in such securities.

An Ideal Investment for Beginners

As an early investor who tends to invest in the money market, this type of stock is a good option for starting with their investments. It allows investors to get a return and avoid running their capital on highly volatile stocks. If you want your investment to be low in terms of risk factors, then you should try to buy stocks for the time when you don’t get enough knowledge about the Stock Market.

Chance of a Steady Income Stream

As you are aware, the dividend fund in the stock market. A dividend means a small profit share that a company provides to its shareholders, despite the market being bullish or bearish. These stocks will give you a decent dividend and provide a steady income for the investors. And still, if the market conditions are volatile, you get a dividend on the determined time of the company. But before you buy any stock, you must identify the defensive stock and the company product or service, how it’s one of the primary necessities, and why people buy it regularly. 

Traditional Valued in P/E and P/BV Terms

One of the oldest qualities of defensive stocks is their undervalue in P/E and P/BV. Most big corporations in the Indian Stock Market. You can observe the valuation of these companies is high. These companies also have a potential where growth is limited, and the size of work is fair enough for them. But you can assure that this company’s downside risk is pretty stable. And when there is a period of bearish or market fall, you can buy these stocks and wait until they bounce back to their stable or more than that initial value of the stock.

Conclusion

However, one should note that defensive stocks are still susceptible to some volatility and fluctuations. They are not investments like fixed deposits that guarantee returns even during economic recessions and crises. At times, the stock price may fail to increase by a significant number and may enter an extended consolidation phase. However, defensive stocks will continue to provide dividends to their shareholders as long as the earnings are stable. 

Hence one must evaluate the risk one can afford to bear and invest accordingly. Just because a company belongs to the FMCG or utility industry, one should not consider them a good investment option for a defensive stock. The business has to generate consistent profits to fall under defensive stocks regardless of the industry.  

It is necessary to determine whether the stock is an excellent defensive stock by conducting a thorough fundamental analysis. If the management is poor, a defensive stock can also crash and may not recover. On the other hand, as long as the management of the underlying companies is competent, these companies will be cash-rich.

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