Defensive stock is a stock that delivers consistent returns to its shareholders, irrespective of the ongoing volatility in the market. The tenacity in the financial performance of the company is mainly based upon the product line the company is engaged into.
Generally, companies identified as defensive stocks are into the provision of goods and services that meet the daily requirement of consumers. Say for example, the companies engaged in the business of providing basic necessities such as consumer staples, healthcare, water, gas and electric utilities.
But that is just good enough to cover the broad understanding of the stock. The crux lies in many factors that distinguish the defensive companies sometimes within the same industry.
- Beta- It’s not anything alien! Beta is a term used to specify the systematic risk associated with the stock of the company and the prevailing volatility in the market. Defensive stock companies will always try to maintain a low beta, so that, at the time of recession or market fluctuation they are minimally affected compared to the other market players.
- Historical performance- The defensive stock ensures to return constant dividend and earnings to its shareholders. Therefore, the investors needs to turn to the company’s previous balance sheet and see if the dividend payout ratio and EBITDA margins are maintained at constant rate with marginal growth year on year.
- Stable stock price - The investors should analyze the previous trends of the stock price and the percentage change over the period of time. Since defensive stocks have the least correlation with the economic factors, the stock prices are more or less maintained at a stable level instead of showing the extreme up or down movements.
- Product Line- Products and services offered by the company are of utmost importance. The company recognized as defensive stock is usually engaged in the provision of the goods and services, for which the demand always exist in the market irrespective of change in the disposable income of the person and the economic market conditions. Fast Moving Consumer Goods (FMCG) and Healthcare sector always underscore the best examples of sectors having defensive stock companies. Like Consumer staples’ giant, Woolworths Group Limited (ASX: WOW) is one of the defensive stocks as people will never stop to shop for groceries and other essential Supermarket items. The leisure giants and wine & brewing companies like Treasury Wine Estates Limited (ASX: TWE) are often considered as defensive stock options because the target audience of these companies still find ways to manage the change in economy and continue to demonstrate their affection for drinks etc. Another major sector of defensive stocks is the health care services sector. Here, we see companies like Ramsay Health Care Limited (ASX: RHC) and Starpharma Holdings Limited (ASX: SPL) coming under focus. Then, another sector with defensive characteristics is Funerals. You also have some industrial stocks like Transurban to look upon.
Many a times defensive stocks are used for hedging where the risk associated with high growth stock can be averaged out with the stability provided by the defensive stock in the portfolio. Usually it has been seen that defensive stocks are chosen by the conservative investors who target to earn the fixed amount of return in the form of dividends and earnings.
But the major concern with identifying a right defensive stock is that the market doesn’t trade on fundamentals at times; and then the defensive stocks get hit as bad as any other stock in the market. Nonetheless, investors should try to balance the portfolio with some interesting defensive stocks to leverage from.