Why Invest in Defensive Stocks
The stock market provides stocks for every type of investor, whether its aggressive, conservative and defensive stock. Investors choose the stocks depending upon their goals and their risk capacity. Some choose aggressive stocks, which tend to have high risk, while some choose conservative stocks which tend to have low risk. But some investors make tactical investments in order to protect their capital from loss or try to hedge against any economic downturn. One such stock that protects against uneven economic conditions is Defensive Stocks.
The stocks whose earnings and revenues have the potential to hold up fairly during a bear market or a recession is called defensive stocks. It also comes into the category of non-cyclical stocks. Depending upon the economic condition, a stock is broadly classified into cyclical stocks and non-cyclical stocks. Cyclical stocks tend to beat the market, when the economy is in a bullish period and underperform when the economy is in a bearish period. Quite the contrary, non-cyclical stocks perform better during the bad phase of the economy. Let’s look at the characteristics and features of defensive stocks:
They have an orthodox business model, but never go out of demand.
Defensive stocks mainly consist of sectors such as FMCG, banks, medical, and financial services. These sectors may change with time, but the service rarely goes out of fashion. As the economy expands, so does the demand for their products. Even during the recession, when most of the sector is hard hit, these sectors feel less impact. They tend to be less volatile and manage to protect prices as well as returns during tough times. The idea of defensive stocks is to protect the capital first.
Mature and stable business model.
One of the benefits of defensive stocks is that they have mature and stable business models. So, whatever be the situation in the economy, the demand is always there. Their business model hardly requires any change for a long time. For example, the role of cement in the housing industry. The demand for cement can be postponed, but never goes off.
It provides a high dividend yield in the bear market.
One of the best things about defensive stocks is that even in the bear market, they perform quite better than other stocks. It not only protects the capital, but also provides 6-7% dividend yields too, which is higher than other categories stocks. The attractive dividend yield acts as price support for the stock.
Low Beta values also have an element of defensive stocks:
Beta is an important measure of volatility. In case if the beta of a stock is low, it is a defensive stock. Stocks of power companies or automobile companies tend to have a beta lower than one. Such stocks may not rise sharply in bull markets, but they do hold value more consistently, even when the markets are down. There are no hard and fast rules for selecting defensive stocks, but stocks that protect value come into this category.
Reason to invest in Defensive stocks:
There are several reasons to invest in defensive stocks:
An investor who doesn’t have depth idea about investment:
It is better for those, who don’t have much idea about the market. Most of the time, new investors burn their capital by investing in aggressive stocks by undermining the risk. Defensive stocks help them to get an idea about the market first, without much affecting their capital.
If the investor looks for risk-averse:
In the stock market, the risk is proportional to rewards. But every investor doesn’t have an appetite to take a higher risk, as the chances of loss are also high. In that case, defensive stocks pose an excellent choice for the investor, as it reduces the risk quite substantially.
Regular Dividend Income:
There are other ways to make money apart from trading stocks. The dividend is one of the passive ways to make money through stocks. Defensive stocks provide the best dividend in bull as well as bear markets. So, it’s one of the best ways to make money.
When the Markets are highly volatile.
There are some periods in a year, where the market seems to be highly volatile. It’s neither bearish nor bullish. In such situations investing in defensive stocks is one of the best ways to protect your capital and reduce the risk.
*Disclaimer: investment in securities market are subject to market risks, read all the related documents carefully before investing