What are defensive stocks and why are they important?
There’s constant trade off between the risk and return profile of a share. Defensive investments could provide steady performance across various conditions in the financial markets.
Here's what you'll learn in this article:
- What are defensive stocks?
- What are examples of defensive stocks?
- What is the purpose of defensive assets?
- Pros and cons of defensive stocks
- Which stock sectors are considered defensive?
- What defensive ETFs can you add to your portfolio?
- Defensive stocks FAQs
What are defensive stocks?
Defensive stocks refer to companies whose share prices are considered to be relatively stable and less affected by changes in general economic conditions. They can usually receive predictable earnings due to providing essential services and goods that are in constant demand by consumers, even during market downturns.
What are examples of defensive stocks?
Defensive stocks are often found in the consumer staples industry, which tends to have regular demand and spending is less affected by customers’ levels of disposable income. Supermarkets like Woolworths ($WOW) usually have relatively stable earnings due to consistent demand for food and personal care items. These products are usually prioritised ahead of non-essential consumption during periods of economic downturns and financial uncertainty. See this list for more ASX defensive stocks.
Another firm that could benefit from these trends is Amcor ($AMC), which manufactures packaging for major brands in the consumer staples, healthcare, beverages and personal care sectors. Blue chips with well-established brands such as Coca-Cola ($KO) also have a strong track record in the area, with a diversified range of drinks that are popular low-cost treats.
There are also some essential services, such as health care, which are integral to a well-functioning society. Firms like Sonic Healthcare ($SHL) study the nature and causes of various diseases, while others, such as Kenvue ($KVUE), are the home of everyday brands, including Band-Aid and Listerine.
Another area commonly associated with defensive stocks is utility companies, with electricity providers like NextEra Energy ($NEE) being the backbone of the modern economy.
What is the purpose of defensive assets?
The main reason to buy defensive shares is to add stability and reduce the overall levels of risk in an investment portfolio during market downturns. With rather consistent demand and stable earnings, defensive stocks can provide steady returns compared to growth-focused stocks. This can help with capital preservation and play a role in keeping the value of a balanced portfolio from falling across parts of the business cycle.
Defensive stocks won’t provide the same high returns as those oriented on future growth, such as technology shares. However, they tend not to experience the same levels of volatility if macroeconomic conditions change and will have been less affected by rising interest rates than tech stocks. They’re often well-established firms with relatively predictable patterns of demand for their products and their advancement comes from smaller gains.
🎓 Learn more: What is risk management in finance?→
Pros and cons of defensive stocks
Understand the advantages and disadvantages of defensive stocks below:
Pros | Cons |
|---|---|
Tend to provide stability as part of an investment portfolio. They can preserve capital and valuations across various market conditions. | Lower growth potential, often already mature firms in established industries. They can underperform compared to growth stocks during boom periods. |
Relatively steady earnings due to consistent demand and low volatility in share prices. | Could become overvalued during slow economic conditions simply due to their reputation as defensive. |
Many pay regular dividends due to regular earnings, which provides a counterbalance of possibly lower capital appreciation. | Some areas, like utilities, are affected by interest rates. Regulations have big impacts on utility and healthcare firms. |
Tend to hold up well during economic downturns and provide downside protection, unlike growth stocks. | Not without risks, returns can still be negative during recessions. Defensive qualities are relative to other types of stocks rather than certainties. |
Which stock sectors are considered defensive?
Defensive stocks tend to be found in the healthcare, consumer staples and utilities sectors. These segments of the economy tend to have relatively steady demand from customers whether in bear or bull markets. They often provide services and products that are regularly used by the majority of people and usually can’t be delayed indefinitely. They differ from firms in other areas, such as the consumer discretionary sector.
During an economic downturn, many consumers could delay some purchases like new clothing or holidays if they have financial concerns. Businesses worried about upcoming economic cycles and the impact of rising interest rates could also decide against or push back starting dates of new projects. This can have a flow-on effect on many other parts of the economy, right down to the raw materials from the commodities sector used as inputs.
What defensive ETFs can you add to your portfolio?
A number of exchange traded funds (ETFs) provide access to defensive stocks. Those covering the consumer staples sector include iShares Global Consumer Staples ETF ($IXI) on the ASX, as well as several on U.S. exchanges including Vanguard ($VDC) and SPDR ($XLP).
Exposure to the global healthcare sector is available through the iShares Global Healthcare ETF ($IXJ) and BetaShares Global Healthcare ETF - Currency Hedged ETF ($DRUG). Investing in the utilities sector is possible with SPDR ($XLU) and Vanguard ($VPU) on Wall St.
More resources:
✅ A complete guide to the core-satellite approach→
✅ Understand what a dividend reinvestment plan is→
✅ What is a good P/E ratio for stocks?→
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Defensive stocks FAQs
Defensive stocks help provide downside protection during periods of volatility and when there’s a slowdown in the economic cycle. In these times the price of a defensive stock can be more stable and they could still pay out dividends, which could be a less likely situation for growth stocks. Owning defensive stocks could be a useful part of an investment strategy and provide a counterbalance to higher-risk shares.
The performance of cyclical stocks tends to be tied to different phases of the business cycle. They tend to benefit from economic growth and increased consumer spending, this is also associated with lower interest rates and positive forward looking expectations. Their revenues can be volatile and share prices are often influenced by general shifts in the stock market.
They’re often found in sectors such as consumer discretionary goods and services, construction and commodities, but some other sectors might also underperform during downturns. Cyclical stocks can provide higher returns during periods of economic expansion and be used together with defensive stocks to form a balanced portfolio.
The drivers of demand for the goods and services offered by defensive companies tend to be less dependent on the general state of the economy. Whether it’s a bear or a bull market, people will still buy food and personal care items, they will also use electricity and healthcare services. Certain sectors can have defensive characteristics depending on the specific period of time, they are not always fixed.
The margins are often low for these firms, but they benefit from economies of scale where growth depends on steady and smaller gains. The performance of growth stocks is more exposed to economic cycles. They usually benefit from optimism towards the future and can provide investors with high returns during boom periods. However, this also makes them more sensitive to downturns.
This does not constitute financial product advice nor a recommendation to invest, it is for informational purposes only. Past performance is not a reliable indicator of future performance. As always, do your own research and consider seeking appropriate financial or taxation advice from a licensed adviser before investing.
Megan is a markets analyst at Stake, with 7 years of experience in the world of investing and a Master’s degree in Business and Economics from The University of Sydney Business School. Megan has extensive knowledge of the UK markets, working as an analyst at ARCH Emerging Markets - a UK investment advisory platform focused on private equity. Previously she also worked as an analyst at Australian robo advisor Stockspot, where she researched ASX listed equities and helped construct the company's portfolios.
