Everything You Need to Know About Defensive Stocks
Author: James Clark
What are Defensive Stocks and their Key Features?
Stock traders invest their money in the stock market for appreciation (profit). However, they must also navigate through the market’s volatility while protecting their portfolio from financial downturns. The best way to do this is by investing in defensive stocks. These stocks won’t make your great profits, but they’re immune to market crashes or recessions and continue to perform consistently. Plus, if you’re a trader with lower risk tolerance, you can use them to preserve your capital.
In this article, we’ll explain what defensive stocks are, which industry sectors have them, and who should invest in them.
What Are Defensive Stocks?
Defensive stocks are among the least volatile stocks in the market. Traders rely on them to provide consistent returns even during financial downturns. These stocks typically belong to industries or companies that people continue to buy from no matter the economy’s condition.
How to Determine Whether a Stock is Defensive
While there are no fixed parameters or rules to determine whether a stock is defensive, most defensive stocks exhibit the following characteristics:
• Low Volatility (Low Beta)
If a stock has a beta coefficient below one, it shows that the stock’s movement compared to the overall stock market is low, meaning the stock has low volatility and is most likely a defensive stock.
• Low Price-to-Earnings Ratio
Defensive stocks typically have low P/E ratios, indicating that their earning growth is steady. These stocks don’t require traders to pay a premium for them, because they have a low earnings growth potential.
• Strong Balance Sheets
Companies that maintain a low debt-to-equity ratio are generally more established and stable. So, their stocks are often defensive, depending on the industry.
Industry Sectors that Have Defensive Stocks
The following are some of the top industry sectors with defensive stocks:
These include water, gas, and electricity companies, etc. They all offer necessary services and are unaffected by economic downturns.
Healthcare is an essential industry sector that includes several goods and services that consumers will continue to purchase in an uncertain economy. It includes hospitals, pharmaceuticals, and companies that offer medical equipment and insurance.
3. Consumer Staples
Consumers can stop buying luxury cars or accessories when their budgets are down but cannot stop buying necessities, such as food, beverages, and household goods. As a result, companies that offer these products will always be in demand.
In the modern era, we’re accustomed to telecommunications, such as phone and internet providers. As consumers, we will continue to need these products and services.
These are just four of several industry sectors that can have defensive stocks. Some traders consider giant companies in the tech sector, such as Amazon, Apple, and Alphabet to have defensive stocks.
Who Should Invest in Defensive Stocks?
Anyone can invest in defensive stocks. However, most people who invest in these stocks are:
1. Inexperienced Stock Traders
New traders often lose money by investing in unstable, aggressive stocks due to inexperience and eagerness. Defensive stocks help you understand the market first.
2. Traders with Low-Risk Tolerance
In stock trading, your earnings are proportional to the amount of risk you’re willing to take. However, not every investor wants to take too many risks. Defensive stocks are an excellent choice for these investors.
3. Traders in Extremely Volatile Markets
Depending on the time of the year, location, or economic events, the market can become extremely volatile. Traders in this situation can use these stocks to protect their capital.
The bottom line is that defensive stocks are excellent investment tools traders can use to mitigate risk and protect their portfolios. These stocks have become an essential part of a diversified strategy that combines aggressive and non-aggressive stocks. These stocks might not necessarily make you rich overnight, but they will help your ride out tough economic periods.
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