Defensive stocks are not defence stocks. Do not get confused. Defence stocks are the stocks of companies engaged in the defence industry. Defensive stocks are completely different from defence stocks. Then, what are defensive stocks?
Explore this article to understand it as it includes defensive stocks, which industries have defensive stocks, their characteristics, pros, cons and their role in your portfolio.
What is a Defensive Stock?
Defensive stocks generally give consistent returns irrespective of the state of the overall stock market or economy. The term ‘defensive’ states that these stocks are likely to protect your investment from the adverse effect of market or economic downturn.
Characteristics Of Defensive Stocks
1. Lower beta
Beta indicates the stock volatility relative to the benchmark index (Nifty 50, Sensex, etc.). Defensive stocks usually have a low beta, typically less than 1, suggesting that the defensive stocks are less volatile than the overall market.
For instance, if a stock’s beta is 0.6, it suggests that when the market goes up by 10%, it is likely to increase by 6%. It also means that if the market goes down by 10%, the stock price may drop only by 6%.
2. Belongs to non-cyclical industries
Some businesses, such as automobile companies, see higher demands when the overall economy is doing well and lower demands in the recession or bearish phase. And some businesses, such as FMCG companies, have stable and predictable demands irrespective of the state of the economy. Defensive stocks belong to businesses like FMCG.
3. Attractive dividend yield
Defensive stocks offer higher dividend yields. You may earn consistent returns by investing in defensive stocks, as some of them regularly pay dividends. Some defensive stocks that have paid higher dividend yields in the past are ITC Limited, ONGC, Oil India, GAIL, Coal India, etc.
Which Industries Have Defensive Stocks In India?
People need basic utilities like gas, electricity, water, etc., daily. Therefore demands for such services are not so sensitive to the economic cycle. Companies engaged in providing utilities would probably enjoy stable earnings. Consequently, utility stocks are less likely to drop significantly, even in unfavourable market conditions.
2. Consumer staples
Companies engaged in producing and selling food, beverages, hygiene products, certain household items, tobacco, alcohol, etc., may see stable and predictable demands as people consider them necessities to support their daily lives, or they may consume such goods out of habit. Though stocks of these companies may not offer great returns during a strong economy, they may outperform consumer discretionary stocks (stocks of companies involved in car manufacturing, hotels, luxury items, etc.) in weaker economies.
Medical needs are usually irresistible and unavoidable. Therefore, insurance, pharmaceuticals, etc., can be considered defensive sectors that are likely to perform well even in a market fall. During the COVID-19 pandemic, many pharmaceutical stocks performed well when the overall stock market was stressed.
Pros Of Defensive Stocks
Defensive stocks belong to the sectors which do not go out of fashion and have stable and predictable demands, which may enable them to offer steady returns for a long time. Investors who cannot stomach higher volatility may consider these stocks.
2. Lower risk
Though any investment inherently involves risk, defensive stocks are considered relatively less risky, as they are less likely to lose their value significantly. Investors who prefer capital protection over high-risk-high-returns may pick defensive stocks.
3. Outperformance in economic decline
In economic decline, most companies might see temporary drops in revenue. However, defensive stocks are likely to perform better than the overall market. They may maintain their earnings during that time, enabling them to provide returns in the form of dividends. Plus, many investors move towards these stocks in the unfavourable market, which may result in price growth.
Cons Of Defensive Stocks
1. Lower probability of significant returns
A limitation of defensive stocks in India is that they rarely offer quick and significant returns. They may help investors protect their wealth but may not help them quickly build wealth.
2. Higher price
If you turn to defensive stocks during an economic slowdown, you may find them high-priced or overvalued because many investors do the same. High demand results in a price rise, which may decrease your probable returns from the stock.
3. Underperformance in an economic boom
When defensive stocks are likely to perform well in an economic slowdown, they may perform poorly in an economic boom compared to the overall market. They would not see significant demand growth in an economic boom, which may not enable them to provide great returns.
What Is The Role Of Defensive Stocks In Your Portfolio?
When the market is in a bullish phase, you would be happy to see your investments growing in value. The stress comes when the market undergoes a bad phase. There comes the role of defensive investments, which may help protect your portfolio from losing significant value during that time.
Defensive stocks may protect your investments from losing value in unfavourable market conditions. However, the increased weightage of defensive stocks may not allow you to enjoy significant returns when the market is doing well. Therefore, it is important to make investment decisions after understanding the ongoing market conditions.
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Some of the features of defensive stocks in India, which may help you identify them, are stocks with beta typically lower than 1, higher dividend yields, stable earnings irrespective of market conditions, etc. Such stocks usually belong to businesses from utilities, consumer staples, and healthcare industries. However, picking them after thorough research is always better.
A good defensive stock is one which belongs to businesses from utilities, consumer staples, and healthcare sectors and has constantly provided stable returns, even in unfavourable market conditions.
Looking at the stock’s price movements during various phases of the market and economy may help you know whether the stock is cyclical or defensive.
– If the stock performs well in a strong economy and poorly in economic decline, it may be a cyclical stock. These stocks usually belong to businesses like automobile manufacturers, airlines, hotels and restaurants, banks, etc.
– If the stock does not get affected much by market swings, it may be a defensive stock. Such stocks usually belong to companies from the utilities, consumer staples, and healthcare sectors.
At the time of writing, there does not exist any defensive stock ETFs in India.