What Are Defensive Stocks?
Defensive stocks are shares in companies whose performance are not highly correlated with the health of the economy, something which appeals to investors with a low appetite for risk. In this article, we will provide a detailed answer to the question, “what are defensive stocks”, highlight top defensive stocks, examine a defensive ETF and much more!
Table of Contents
What Are Defensive Stocks?
Not to be mistaken with defence stocks, defensive stocks are shares of companies which perform relatively consistently, regardless of the health of the overall economy.
Defensive stocks provide goods or services for which there is steady demand throughout the various phases of the economic cycle. The most common example of these is consumer staples, necessities that are unlikely to be removed from a consumer’s budget if there is a downturn in the economy.
During times of economic turmoil, many investors increase their exposure to defensive stocks as a way to protect their capital, as these companies are seen to be more resilient than others and a type of safe haven.
|Inelastic Demand: Companies which produce goods or services whose demand will remain relatively constant regardless of changes in price or disposable income|
|Dividends: Defensive stocks often distribute a proportion of their earnings as a dividend|
|Stable Income: Companies which can rely on stable, predictable income regardless of the health of the economy|
|Lower Risk: Companies which are well-established, experienced, have a large market capitalisation and are relatively immune to market volatility|
What Are Defensive Stock Sectors?
Understanding the different sectors within which defensive stocks operate can help cement our understanding of what defensive stocks are. So, what are defensive stock sectors?
- Healthcare: One of the first which will often spring to mind is the healthcare sector, and it is pretty self-explanatory as to why that is. Unfortunately, people will always get sick and, when they do, healthcare and treatments are often required.
- Consumer Staples: This is a broad term which refers to essential goods bought by consumers. This industry generally includes products such as food, drink, alcohol, tobacco, household products and personal care products. These are all items which enjoy constant and inelastic demand.
- Utilities: Utilities refers to the services of water and energy providers. Such services are modern day necessities and, although usage may decrease in a prolonged recession, demand should remain fairly stable regardless of the wider economic picture.
- REITs: Real Estate Investment Trusts (REITs) are companies which use investor funds to acquire and manage a portfolio of properties which generate income through rent. Investors should focus on REITs which manage apartment buildings as paying rent is necessary in order to keep a roof over your head. However, not all REITs are good defensive choices. For example, some REITs specialise in office space for businesses, which may pose a risk during a prolonged economic downturn.
Defensive Stocks Examples
So, what about specific examples of defensive stocks? Here are a few defensive stocks examples, many of which are well-known global brands.
- Procter & Gamble
- Costco Wholesale Corporation
- Johnson & Johnson
- United Health Group
UK Defensive Stocks for 2022
Now that we know what defensive stocks are and have some examples of them, are there any UK defensive stocks which investors should consider in 2022?
Diageo is a UK based alcohol company which operates in more than 180 countries around the world and is responsible for some of the world’s most recognisable and popular alcohol brands.
Amongst its stable of products are Johnnie Walker and Smirnoff, two of the world’s four largest international spirits brands by retail sales value. Other notable product lines include Guinness, Tanqueray, Gordon’s, Baileys and Talisker.
Alcohol falls into the category of consumer staples, as it is a product that people will tend to buy regardless of what is happening in the overall economy.
In the ten years between 2011 and 2021, this UK defensive stock has provided shareholders with an annualised total return of 13%, considerably outperforming the UK’s FTSE 100 index, of which it is a member, over the same time period. At the time of writing, Diageo pays a dividend yield of around 1.9%.
For those looking to protect and grow their capital during the uncertain times we find ourselves in, rather than purchasing one or two defensive stocks, it is often better to diversify your holdings over several to protect yourself against risk.
Finding a defensive ETF (Exchange-Traded Fund) is an excellent way of doing this for retail investors. A defensive ETF uses a pool of investor money to invest in shares of defensive stocks and other defensive assets, allowing investors to easily gain exposure to numerous assets with a single investment.
One example of a defensive ETF is the Consumer Staples Select Sector SPDR ETF. As the name suggests, this is a consumer staples ETF which focuses solely on buying shares in companies which produce these types of products.
At the time of writing, April 2022, the top five holdings of this defensive ETF are as follows:
|Proctor & Gamble Company (15.66%)|
|Costco Wholesale Corporation (10.74%)|
|Coca-Cola Company (10.42%)|
|PepsiCo Inc. (9.81%)|
|Philip Morris International Inc. (4.66%)|
Source: State Street Global Advisors – Date Captured: 19 April 2022
Whilst many investors only think of investing in defensive stocks during a market downturn, they can offer considerable value for long-term shareholders. Jumping in and out of defensive positions in an attempt to time the market cycle often fails and can result in comparatively lower returns than simply buying and holding.
The reliable, defensive type of industries we have highlighted in this article may seem less “exciting” than investing in trendy stocks you read about in the news. However, you only need to look at Warren Buffet - one of the most successful investors ever, whose value investing philosophy revolves around identifying these types of companies - to see that investing in defensive stocks can be rewarding.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.