What are defensive stocks? - Pinetree Securities

What are defensive stocks?
Lesson December 21, 2022

What are defensive stocks?

What are defensive stocks?

What’s the defensive stock?

Defensive stocks are stocks that always provide stable dividends and income despite the volatility of the stock market. This is due to the continued demand for the company’s products, so defensive stocks have always remained stable during different stages of a business cycle.

In the world, defensive stocks often belong to long-standing companies belonging to the fast-moving consumer goods group such as P&G (Procter & Gamble), Johnson & Johnson, Coca-Cola… thanks to strong cash flow and ability to overcome challenges. high market. Investors prefer this group of stocks because of its long-term return and low risk compared to other stocks. However, also because volatility is low, the upside margin will not be high.

Features of defensive stocks

  • Defensive stocks are stable throughout different phases of the business cycle. During recessions, they tend to outperform the market. And vice versa, when the market is growing, they will have lower returns than the market.
  • Defensive stocks are not cyclical.
  • Defensive stocks often benefit despite fluctuations in the economy. Because they belong to businesses that produce and distribute essential goods such as food, gas, electricity, and water. These stocks are less affected by the economic downturn.

Three indicators help identify defensive stocks

  • Dividends: Enterprises issuing defensive shares will pay annual dividends. In the event of not paying cash dividends, stock dividends will also be paid. On the contrary, if the dividend is paid in cash and shares at the same time, then cash accounts for a larger share.
  • BETA Index: Is an index that shows the stability, little volatility of the stock. For defensive stocks, it is required to have a BETA index < 1.
  • P/E ratio: It is an indicator of market valuation with earnings per share. Therefore, it is one of the suitable indicators for stock valuation. With defensive stocks, the P/E ratio is usually low.

Pros and cons of defensive stocks

  • Advantage

The distinguishing feature of defensive stocks is that they offer long-term returns and lower risks than other stocks. Warren Buffett became one of the greatest investors of all time in part because of his focus on defensive stocks. According to some investors, they don’t necessarily have to take on excessive risk in order to have yields that beat the market. Conversely, they invest in defensive stocks to reduce portfolio risk.

  • Disadvantage

The low volatility of defensive stocks, even during a strong bull market, often leads investors to feel frustrated selling defensive stocks. When the market went through the growth phase and was adversely affected by negative factors causing a sharp decline, many investors rushed to buy defensive stocks even though it was actually too late.

Investors cannot control the cycle of the economy, but they can adjust their investment activities to market trends and flows. Investing in defensive stocks eases investor anxiety because they don’t carry as much risk as conventional stocks, making them suitable for risk-averse investors. To choose the right defensive stocks, investors should use fundamental analysis.

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