What are defensive stocks? Definition, advantages, drawbacks - Business Insider

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11/27/2020 9:28:00 PM

What are defensive stocks? Stocks that provide stability to your portfolio regardless of whether the economy is up or down

Business Insider tells the global tech, finance, markets, media, healthcare, and strategy stories you want to know.

Low volatility:beta coefficient,which measures a stock share's movements compared to the overall stock market's is low — ideally below one. This indicates that the stock isn't greatly affected by market swings. The beta coefficient is a complex economist's tool, but you can often find it in analyst's reports on a company, or it may be included in its online stock listing.

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Conservative investors and investors who are investing to preserve capital often lean toward defensive stocks because of their reliability, while more aggressive investors may avoid defensive stocks altogether and protect their wealth by maintaining a buffer in cash and/or bonds.

However, a mix of both is usually wise. By developing an investment strategy that includes a healthy balance of both defensive and cyclical stocks in your portfolio, you're able to shield against total loss during a downtown and make the most of periods of economic growth. headtopics.com

Which industries have defensive stocks? Defensive-stock companies are usually found in these fields or sectors:Utilities:Companies in the electric, water, gas, and waste management sectors offer necessary services, and continue to operate as usual through economic downturns. 

Consumer staples:When consumers are cutting their budgets down to bare-bones necessities, staples like household goods, toiletries, tobacco products, and food and beverages likely won't be eliminated. Within these, it can be smart to opt for companies that prioritize affordable brands.

Healthcare:Healthcare is another good or service that consumers will continue to purchase in an uncertain economy, and for that reason, it's performed well over through recessions in the past. This sector includes insurance, pharmaceuticals, medical devices, and hospitals.

Telecom:Telecommunications, which includes cable, phone, and internet service providers, are services that consumers never stop needing. They might cut back on or downgrade during hard times, but for the most part, these businesses' revenues stay pretty stable. headtopics.com

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Discount retailers:When the economy plummets, consumers pivot toward value. While most retailers tend to suffer during a recession, the ones that do well are those that help people get the best bang for their buck. These are companies that operate with large economies of scale and offer lower prices relative to their competitors.

These are the traditional defensive sectors. But it's possible for a company that's not necessarily in a "recession-proof" industry to still have stock that's considered defensive because of the company's size, history, and proven ability to adapt to changes in the market. 

For example, some investors might argue that certain giants in thetech sector— like Amazon and Alphabet (Google's parent company) — are prosperous, life- and industry-dominant, and adaptable enough to be considered defensive stocks.At the same time, just because a stock is in a defensive sector doesn't necessarily make it a defensive stock. It still has to meet some of the other guidelines mentioned above, such as consistently paying out dividends for a long period of time and having an established, sound financial track record. 

Defensive vs. cyclical stocksDefensive stocks are also sometimes referred to as non-cyclical stocks because they don't follow the cycles of the economy. In fact, they typically underperform when the market is up. Cyclical stocks, on the other hand, are stocks that tend to do well when the economy is doing well. Think luxury goods and services. Of course, these are also the areas that people tend to decline during harsh economic times — the automotive, travel, and high-end retail industries are a few examples. headtopics.com

Some of the difference between the way defensive and cyclical stocks perform has to do with the industries they're in. Being in "recession-proof" industries such as utilities, healthcare, and consumer staples helps defensive stocks weather the ups and downs of the business cycle and makes them less volatile.

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