Cyclical vs. Defensive Stocks - Key Differences Stock Investors Should Know About
Author: James Clark
Understanding the Key Differences Between Cyclical and Defensive Stocks
Cyclical and defensive stocks are among the most common stock types investors can choose to include in their portfolios to reduce their overall risk. When monitoring economic fluctuations and their impact on the stock market, it’s important to understand the difference between cyclical vs defensive stocks to ensure your investment pays off. While one promises higher returns, the other promises long-term stability regardless of economic conditions.
In this post, we’ll share the key differences between defensive and cyclical stocks so you can better decide which one to invest in after evaluating the market conditions.
What are Cyclical Stocks?
Cyclical stocks belong to companies that produce and sell non-essential, discretionary products and services that are in high demand in a flourishing economy with a low unemployment rate and high income per capita. In a nutshell, they include all goods and services that people stop buying when times are tough. These stocks follow all the economic phases from expansion to peak, recession, and recovery. So, when the economy turns down, cyclical stocks fall in terms of price.
Restaurants and hotels
Spas and resorts
Cinemas and amusement parks
Non-essential consumer electronics and accessories
What are Defensive Stocks?
Defensive stocks, in contrast, belong to companies that produce and sell essential products and services that people will continue to buy regardless of the economic conditions. As a result, they offer regular and stable income to stock investors that include them in their portfolio, even during times of recession. These stocks are characterized by a history of success, at least a decade of paid dividends, and low volatility.
Consumer staples eg. Food
Utilities (gas, electricity, and water)
Telecommunications (Internet, phone, and cable)
Cyclical vs. Defensive Stocks – 4 Key Differences
Without further ado, let’s check out the 5 key differences between cyclical and defensive stocks:
The performance of cyclical stocks is highly dependant on the overall performance of the economy. For example, stock prices rise during economic expansion and fall during a recession. In contrast, defensive stocks function independently of economic conditions as consumers continue to buy essential goods and services.
2. Risk and Returns
Cyclical stocks are a riskier investment, and therefore bring about higher returns by outperforming the stock market during a bull run. In contrast, defensive stocks are a safety net for most investors since their relatively less volatile meaning they don’t offer extraordinary returns.
Cyclical stocks are highly volatile, meaning stock prices fluctuate regularly as economic conditions change. Meanwhile, defensive stocks considerably less volatile since they’re unimpacted by economic conditions.
The beta coefficient tells you how much a particular stock moves in terms of price compared to the overall stock market movement. Defensive stocks have a beta lower than one, meaning their prices remain pretty much the same regardless of market swings. In contrast, cyclical stocks have a beta higher than 1.
Now that you understand the key differences between cyclical vs defensive stocks, you can make more informed trading decisions after evaluating the overall economic conditions. If you’re a high-risk taker seeking maximum returns, we recommend buying cyclical stocks to expand your portfolio. If you want to avoid sleepless nights and opt for less risky investments with lower but stable returns, defensive stocks are the right option for you.
1. The Home Depot, Inc (HD)
2. Penske Automotive Group, Inc (PAG)
3. American Axle & Manufacturing Holdings, Inc (AXL)
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