What are the best defensive stocks to buy?

Stocks from across sectors face headwinds amid business cycles. The pandemic, for one, has triggered a major hit to operations for companies across the board, thus keeping their profits subdued.

Despite this hit, some stocks have managed to bring investors gains through their steady dividend distribution and resilience against poor macroeconomic conditions.

Such stocks, which have stable dividends and robust fundamentals to defend themselves from an overall weak market, are described as defensive stocks.

Let’s now dive in to have a closer look at the defensive stocks: 

What makes a company a defensive stock?

A defensive stock’s role in a portfolio is to provide stability and returns even as investment income from other volatile and riskier investments start to dwindling. These are considered an important constituent of an investment portfolio because of their reliability for distributing dividend income.

The stability in defensive stocks exists due to constant demand for the products and services offered by the companies, even as the stock market fluctuates based on changes in the macroeconomic situation. Their offerings are basic to the human condition, such as water, gas, electricity, or household staples, among others.

A defensive stock’s volatility, determined by its “beta coefficient”, usually remains low. The beta coefficient reflects the stock’s volatility against the overall market.

The lack of volatility in defensive stocks can also be attributed to the constant demand for their products as well.

However, the ability to provide stable returns also means that these stocks do not see a dramatic jump in their returns during a stock market rally.

Another important parameter to be classified as a defensive stock is its long-established presence as a reliable market player. Generally, companies that have had stable operations for at least a decade or more are eligible to be called defensive stocks. These players, mostly, have a large market capitalization, which reflects investors’ faith in its operations.

However, many a times, investors are unable to differentiate between defensive and cyclical stocks. Let’s break that down here:

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How to differentiate between defensive and cyclical stocks?

As the name suggests, defensive stocks essentially “defend” themselves against market fluctuations, macroeconomic shocks and a changing consumer behavior to keep their earnings growing consistently. These stocks, therefore, are less risky as an investment.

Cyclical stocks, on the other hand, move in accordance with the overall market conditions. A weak market prompts a dip in the demand for these stocks, and subsequently, their operations.

This is because cyclical stocks’ offerings are generally discretionary in nature, and buyers do not always demand such products and services to meet their necessities.

A recession, or a major shock to the economy, could lead to a decline in their growth. However, a pickup in economic conditions is first evident in the growth trajectory of these stocks as increased income leads to higher discretionary spending.

Generally, the beta coefficient for these stocks is also high.

Despite higher risk and volatility, investors are often attracted towards cyclical stocks because of their high returns. However, it is unlikely for such stocks to provide stable, long-term dividends.

Some sectors belonging to the category include real estate and automobiles.

A key difference between the two kinds of stocks is that while defensive stocks provide long, stable dividend returns, they are less likely to outperform the market during a bull run. Cyclical stocks, on the other hand, may turn out to be outperformers albeit accompanied by high risk.

Let’s now look at some major defensive stocks in the US and Canadian stock markets.

Some of the best defensive stocks in US and Canada 

Enbridge Inc. (TSX:ENB) : Enbridge is an integrated energy company, one of the largest in Canada, with a market capitalization of about C$ 101 billion. It announced a quarterly dividend of C$ 0.835 on June 1, and has a dividend yield of 6.699 percent.

With about 2.03 billion outstanding shares, its beta coefficient is 0.945.

Metro Inc. (TSX: MRU) : The Toronto Stock Exchange classifies this retail giant as a consumer defensive stock. Metro has market cap of about C$ 14.46 billion, and a dividend yield of 1.70 per cent.