Defensive Stock - Learning the Basics
A Defensive Stock may be best defined as a stable stock that fetches a constant dividend and remains unaffected by the overall volatilities of the stock market. As a matter of fact, during economic slowdown, defensive stocks often outperform most other stocks in the market.
It is important to not confuse defensive stock with defense stock, which are stocks that provide a defense against volatility, or with defense stocks which pertain to stock of companies that deal in manufacturing of defense equipments and military supplies.
Investors familiar with stock market operations will know that Defensive Stocks are not cyclical in nature and as the very term suggests, Defensive Stocks help protect the stockholder from financial losses whenever stock markets crash or turn bearish.
The reason for this is quite simple. Defensive Stocks are generally stocks belonging to sectors where demand for goods and services do not fall as much as other areas during economic recessions. Common defensive stock sectors are public utilities companies like gas, electricity and other essential commodities - which the consumers can ill-afford to do without. Defensive stocks may also include food, tobacco, medicine and toiletries.
Likewise, the prices of defensive stocks are not expected to experience significant upward swing during times of economic boom. Car manufacturers, for instance, are not defensive stocks because people are more likely to buy cars when the economic climate is favorable and postpone car purchases when times are tougher.
Defensive stocks also benefit during economic downturns because many investors prefer to shift investments from cyclical stocks like real estate, building materials, luxury items, steel, automobiles and other luxury items to non-cyclical ones in their stock portfolios.
Many people believe that gold stocks are a good defensive stock - more so, during a bear market. However, gold is more of a hedge against inflation, than against a downward moving economy. You can combine your knowledge of stocks with knowing about global investment banking to understand how stocks are affected by international fluxuations.
Long-term players in the market understand the value of defensive stocks and will generally allot a percentage of their total portfolio investment for Defensive Stocks and will opt to increase their portfolio allocation in defensive stocks during times of economic downturn. But it must also be borne in mind that that a Defensive Stock will not fetch the investor handsome gains during the bull phase in the stock market. Therefore, one’s portfolio should be a mixed bag based on risk tolerance. In short, one can buy Defensive Stocks and hold them as a safety measure without however expecting big gains.