What are defensive stocks: definition, examples and stocks to watch
Rebecca Cattlin August 1, 2022 4:15 AM
Defensive stocks are a popular tool for investors looking to diversify, but are they as useful for speculative traders? Learn everything you need to know about defensive stocks and why traders still choose these low-volatility assets.
What are defensive stocks?
Defensive stocks are the shares of companies that see a continuous demand for their products, which means that they tend to be more stable during economic downturns than ‘risk on’ or ‘growth’ stocks. That’s why they’re used to ‘defend’ a portfolio.
Defensive stocks provide consistent dividends and stable earnings regardless of the performance of the wider stock market. So, when there’s an economic downturn, share prices of defensive stocks usually rise as investors rush into what they perceive as safe-haven stocks. But during expansionary phases, defensive stocks perform below the rest of the market.
Why trade defensive stocks?
You’d trade defensive stocks for much the same reason as investors buy the shares: to diversify your positions. For example, rather than going all-in on tech stocks that are more susceptible to price fluctuations, you can spread your risk across both cyclical and defensive stocks.
There are some large stocks that are considered defensive plays, but in general, these low volatility stocks aren’t as popular with retail traders due to less impressive growth. However, in periods of economic downturn, the safe-haven inflows can still create opportunities for speculation.
Learn about low volatility trading
Examples of defensive stocks
There are a lot of sectors that are typically considered defensive. Let’s take a look at each, and an example of a leading company in the industry.
- Utilities: United Utilities
- Defence: BAE Systems
- Consumer staples: Coca-Cola
- Healthcare: GlaxoSmithKline
Water, electric, gas and broadband supply utilities are examples of defensive stocks because we all still need them during all economic cycles.
Utility firms can benefit from a slower economic environment because interest rates tend to be lowered by central banks to guard against the worst effects of a recession; therefore, consumers can still afford to heat their homes and buy petrol at the pump.
Example: United Utilities Group
United Utilities is one of the largest water and wastewater companies in the UK, supplying services in the northwest of England. As water is essential for all households and businesses, the company has a history of performing well in periods of economic downturn.
Defence stocks – the shares of companies that manufacture military weapons, ammunition and fighter jets – shouldn’t be confused with defensive stocks, but they are an excellent example of a consistent earnings provider.
These companies are often at the forefront of many scientific and technological developments, and always have a consistent customer base.
Example: BAE Systems
BAE Systems is one of the world’s leading global defence, security and aerospace companies working at the cutting edge of technology, and operates in markets such as the US, UK, Saudi Arabia, and Australia.
It creates upwards of 100 new inventions annually for customers in more than 100 countries. In addition, BAE designs, develops, integrates and provides products in areas as diverse as life support and naval combat systems.
See some other defence stocks to watch in 2022
Firms that produce or sell consumer staples – which people buy out of necessity – are generally thought of as defensive whatever the economic condition. Supermarkets are a good example.
They sell food, drinks, tobacco and household items. The supermarkets and the companies that fill their shelves generate steady cash flow and more predictable earnings during strong and weak economies. As a result, such stocks often outperform cyclical stocks that sell discretionary products.
Coca-Cola is one of the most popular defensive stocks due to its status as one of the world's most recognisable brands. Other than the flagship beverage we all know, it manufactures and distributes nearly 500 other products.
The pandemic hit Coca-Cola, and earnings slumped year on year. However, compared to other companies in the sectors, the business managed the situation well.
Pharmaceutical firms and medical device makers have historically been considered defensive stocks because people will always be sick and in need of care.
But as with any sector, some healthcare stocks are risky. For example, in 2020-2021 when just about any listed pharma firm claimed to be making a Covid-19 drug breakthrough, it caused a huge surge in prices – known as a bubble.
GlaxoSmithKline is a key player in the UK (and global) healthcare industry. It researches, develops, manufactures and sells a huge range of medicines and vaccines, as well as medical instruments and technologies.
Thanks to its diverse offering, GSK is also considered more stable than other healthcare companies, which helps to offset any other risk exposure the sector typically has during bubbles.
How to trade defensive stocks
You can trade defensive stocks with FOREX.com in these easy steps:
- Open a FOREX.com account, or log in if you’re already a customer
- Search for ‘X’ in our award-winning platform
- Choose your position and size, and your stop and limit levels
- Place the trade
Or you can practise trading defensive stocks risk free by signing up for our demo trading account.
How to find good defensive stocks
The main way of finding a defensive stock is by looking at its beta – a measure of a stock’s volatility compared to the wider market. Typically, defensive stocks will have a lower beta, as they’re less affected by price swings.
Learn more about calculating stock volatility
It’s best to create a set of parameters for the stocks you’re interested in, otherwise you’ll end up combing through the entire stock market to establish which defensive stocks to invest in. For example, you might narrow your search to a particular country, sector or index.
You can also identify defensive stocks by looking for companies that have consistently paid out dividends over the years, including during recessions.
But there is no one-size-fits-all method to evaluate defensive stocks. Some firms have paid out a combination of high dividends and enjoyed significant share price growth compared to their peers. Others have seen their share prices fall but continued to pay out dividends.
Using various measurements, such as the dividend yield, EPS and P/E ratio, together with the share price movements of the short, medium and long term, should enable you to make informed decisions about which defensive stocks to trade.
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