What are defensive stocks: definition, advantages and stocks to watch
City Index June 30, 2021 3:38 PM
Defensive stocks are thought of as stable investments during periods of economic downturn, so they’re bought as a form of hedging in portfolios. Discover what defensive stocks are and how to use them.
What are defensive stocks?
Defensive stocks are the shares of companies that have continual demand for their products, so they tend to be more stable during most business cycles than ‘risk on’ or ‘growth’ stocks. This means they usually provide consistent dividends and stable earnings regardless of the performance of stock markets.
When there’s an economic downturn, investors often look to shore up their investments by rushing to what they perceive as safe haven stocks – defensive stocks are perceived this way as their value usually falls less than their value or growth equivalents.
Examples of defensive stocks
Defence stocks – the shares of companies that manufacture military weapons, ammunition, and fighter jets – are an excellent example of defensive stocks because they’re at the cutting edge of many sciences and have a ready-made customer base.
Many other sectors are also considered defensive, for example:
Water, electric, gas and broadband supply utilities are examples of defensive stocks because we all still need them during all economic cycles.
Utility firms can benefit from a slower economic environment because interest rates tend to be lowered by central banks to guard against the worst effects of a recession; therefore, consumers can still afford to heat their homes and buy petrol at the pump.
Firms that produce or sell consumer staples, which people buy out of necessity, are generally thought of as defensive whatever the economic condition. Supermarkets are a good example.
They sell food, drinks, tobacco, and household items. The supermarkets and the companies that fill their shelves generate steady cash flow and more predictable earnings during strong and weak economies. As a result, such stocks often outperform cyclical stocks that sell discretionary products.
Pharmaceutical firms and medical device makers have historically been considered defensive stocks because people will always be sick and in need of care.
But as with any sector, some healthcare stocks are as risky as dot coms. For example, in 2020-2021 when just about any listed pharma firm claimed to be making a CV-19 drug breakthrough, it caused a huge and unsustainable surge in prices - known as a bubble. However, the more established pharma firms like Johnson & Johnson, Merck, Pfizer, and Roche have performed well during periods of economic and market instability.
Why invest in or trade defensive stocks?
You’d invest in or trade defensive stocks if you’re looking to protect your portfolio when the economy is weak or the stock market is experiencing high volatility.
Plus, defensive stocks are often well-established companies with a long history of stock market earnings and dividends, so they’re often of interest to dividend investors, or to anyone looking to find long-term gains with lower risk than other stocks.
Defence stocks also provide a means of diversifying a portfolio. For example, rather than going all-in on tech stocks that are more susceptible to price fluctuations, you can spread your risk across both cyclical and defensive stocks.
How to trade defensive stocks
You can trade defensive stocks with City Index with spreads from 0.1%. Follow these easy steps to start trading.
- Open a City Index account, or log in if you’re already a customer
- Search for the company you want to trade in our award-winning platform
- Choose your position and size, and your stop and limit levels
- Place the trade
How to find good defensive stocks
The main way of finding a defensive stock is looking at its beta – the measure of a stock’s volatility compared to the wider market. Typically, defensive stocks will have a lower beta, as they’re less affected by price swings.
It’s best to create a set of perameters for the stocks you’re interested in, otherwise you’ll end up combing through the entire stock market to establish which defensive stocks to invest in. For example, you might narrow your search to a particular country, sector or index.
You can also identify defensive stocks by looking for companies that have consistently paid out dividends over the years, including during recessions.
Defensive stock advantages
There are a number of advantages to investing in defensive stocks; these include:
- Creating a starting point if you’re new to the market – defensive stocks can be a terrific investment and trading starting point for inexperienced investors and traders as they should, in theory, be less volatile, rise and fall in tighter ranges, and be more predictable than growth stocks
- Reducing the impact of volatility on your portfolio – during recessions, investors use defensive stocks as a mechanism to protect against losses by generating dividend yields and returns when such value isn’t being created in other sectors. In this sense, defensive stocks can hedge the losses you might experience in other parts of your portfolio
- Providing a more consistent revenue stream – defensive stocks can generate income over and above any other share price increases, and they often deliver the best dividends even in bearish markets
Best defensive stocks
Let’s take a look at some of the most famous defensive stocks spanning consumer staples, utility firms, healthcare and defense stocks.
The delivery sector experienced considerable success during the pandemic because consumers were buying more online. Delivery services became essential, and may even become the ‘new normal’ as demands shift.
FedEx in particular saw an increase in investment throughout 2020 and 2021. The company provides secure foreign delivery services and business services and even has contracts with the US government. Government contracts are highly prized, as they provide a regular source of income during challenging times.
- Past year share price increase 113.3%
- 5-year share price increase 88.56%
- Dividend yield 0.86%
- P/E ratio 26.74
- EPS 11.46
Coca-Cola is one of the most popular defensive stocks due to its status as one of the world's most recognisable brands. Other than the flagship beverage we all know and love, it manufactures and distributes nearly 500 other products.
The pandemic hit Coca-Cola, and earnings slumped year on year. However, compared to other companies in the sectors, the business managed the situation well.
Despite the slump in demand for its products in the first two quarters of 2020, the stock still rose by 14%, and the firm paid out a dividend of 3.04%, causing market participants to view it as a low-risk long-term investment.
- Past year share price increase 14.16%
- 5-year share price increase 21.85%
- Dividend yield 2.99%
- P/E ratio 33.70
- EPS 1.68
Campbell’s Soup Co. (CPB)
The Campbell’s Soup Company doesn’t only make soup, it makes some of the world’s most popular consumer food products. Some of the other brands it owns include Prego, Swanson’s, and Snyder’s. Because they’re affordable, they sell well during harsh economic times. Tasty, cheap foods are always necessary, so if the brands remain popular, Campbell’s will likely always thrive.
The share price fell by 3.98% yearly, but an improved dividend pay-out of 3.03% partially countered this fall. Over the longer ten-year term, the stock has risen by 55%.
- Past year share price rise 2.66%
- 5-year share price fall -21.1%
- 10-year share price rise 55.10%
- Dividend yield 2.98%
- P/E ratio 18.76
- EPS 2.67
BAE Systems PLC
BAE Systems is one of the world’s leading global defence, security and aerospace companies working at the cutting edge of technology, and operates in markets such as the US, UK, Saudi Arabia, and Australia.
It creates upwards of 100 new inventions annually for customers in more than 100 countries. In addition, BAE designs, develops, integrates and provides products in areas as diverse as life support and naval combat systems.
- Past year share price rise 3.30%
- 5 – year share price rise 10.82%
- Dividend yield 4.45%
- P/E ratio 13.2
- EPS 0.4
Lockheed Martin Corp.
Lockheed Martin is a global security and aerospace company employing more than 110,000 people worldwide. The firm is engaged in the research, design, manufacture, integration and sustainment of advanced technology systems, products and services.
The firm is ranked 60th on the 2019 Fortune 500 list of largest industrial corporations.
- Past year share price fall -4.68%
- 5 – year share price rise 62.74%
- Dividend yield 2.64%
- P/E ratio 15.9
- EPS 24.88
McDonald's is the most well-known fast-food chain worldwide, operating franchised restaurants in Australia, Canada, France, Germany, Italy, the Netherlands, Russia, Spain, and the UK. Despite economic hardship, the company sees consistent demand for its products – partly due to the almost cult-like admiration the brand has achieved, and its low prices.
The firm's favourite products include the Big Mac, Quarter Pounder with Cheese, Filet-O-Fish, Chicken McNuggets, and McDonald's Fries.
- Past year share price rise 17.51%
- 5 - year share price rise 89.35%
- Dividend yield 2.21%
- P/E ratio 33.94
- EPS 6.93
Procter and Gamble
The Procter & Gamble Company manufactures and distributes branded consumer packaged goods to global consumers. The company sells products in more than 180 countries through mass merchandisers like department stores, distributors, beauty stores, e-commerce and pharmacies.
It offers products under the brands Head & Shoulders, Pantene, Mach3, Febreze, Bounty and Charmin.
These consumer staples are always in demand, so while the company experiences fluctuations in some of its brands, its portfolio is diversified enough that it usually remains stable.
- Yearly share price rise 15.29%
- 5 – year share price rise 63.97%
- Dividend yield 2.56%
- P/E ratio 25.01
- EPS 5.63
As can be seen by examining the above company data and the most recent metrics, there is no one-size-fits-all method to evaluate defensive stocks.
Some firms have paid out a combination of high dividends and enjoyed significant share price growth compared to their peers. Others have seen their share prices fall but continued to pay out dividends.
Using various measurements, such as the dividend yield, EPS and P/E ratio, together with the share price movements of the short, medium and long term, should enable you to make informed investment decisions.
Defensive stocks key points
- Defensive stocks offer relative price stability, whatever the state of the economy
- Defensive shares also generate dividends as regular income, with the dividend payments countering the slow share growth returns
- Because these companies are so well established and have robust business models, it’s unlikely that their share prices will drop dramatically. Instead, they typically demonstrate slow share price growth
- Many defensive stocks provide essential products or services, helping them remain financially stable through economic downturns
- Experts often refer to defensive stocks as non-cyclical stocks; they perform well regardless of the economy, while cyclical stocks typically do well only when the economy performs.
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