What is a Defensive Stock?
How Does a Defensive Stock Work?
Defensive stocks are usually found in industries that produce necessary and often relatively cheap products that consumers cannot go without. The utility, food and oil industries are common sources for defensive stocks in this regard. Because electricity, running water, food, and gasoline are basic necessities, demand tends to be fairly stable year-in and year-out.
Defensive stocks are most famous for their ability to weather economic dips, but it is important to note that they also tend to ignore economic upswings. In other words, defensive stocks usually outperform the market during recessions and underperform the market during expansions.
Defensive stocks are mathematically identifiable because they generally have a beta below 1.0, meaning that their statistical volatility does not coordinate strongly with the overall volatility of the market.
Why Does a Defensive Stock Matter?
Thanks to the stability of demand for their products, sales and earnings growth in defensive-stock industries tend to remain constant in good times and bad. With this in mind, defensive stocks can provide investors with a great way to hedge their overall portfolio risk. However, investors should not expect eye-popping capital gains from defensive stocks and instead should expect to pay up for the stability of non-cyclical earnings that defensive stocks offer.