Cyclical Vs Defensive Stocks - How to choose stocks for investing?
Not every one of us is an investment guru like Warren Buffett. But we can always strive to become one if we have the knowledge and use the right strategy. Even great investors go wrong at times, but if you know to mitigate risk and thereby reduce your loss, you win over the situation. As an investor in the share market, it is very essential to be aware of different kind of stocks. Stock picking is a very crucial thing in one’s investment journey. Investors tend to invest in cyclical vs. non cyclical stocks depending on their necessity and risk appetite. One should never be too attached to investments; only a logical and rational decision backed by proper research will help you. Investing is an art and patience is very crucial while investing in the share market.
When you invest your money in a company’s share, you should know what factors affect the stock’s performance. There are various macro and microeconomic factors that contribute to the growth of the company. A proper research about the economy, industry, etc. has to be done before investing in a stock. Investing in a stock after taking into account the economic situation is considered as ‘’top-down approach”. The other type of approach is called as ‘’bottom-up approach’’ wherein the company, its background, financial strength, etc. is examined first and then the sector/industry is analyzed and lastly, the economy is reviewed.
The longer the period you stay invested, the probability of getting better risk adjusted returns is more. If you are not aware of how to choose stocks and also don’t have time, you can take the guidance of research experts and equity advisors to take the right investment decision. Never take any decision based on hearsay as you will end up in losses. Have a proper understanding of the goals, your risk appetite, investment avenues and then buy shares. Continuous monitoring of your portfolio alone will help you in the long run as you should be up to date on how each and every stock is performing in your portfolio. Let us learn about cyclical stocks and defensive stocks in this article.
What are Cyclical Stocks?
Cyclical stocks perform in accordance to the performance of the economy. When the economy grows, these stocks tend to give better returns while there is recession in the economy, these stocks deliver negative returns. Let us look at a simple example to understand this. When the economy is in the pink of health, people start spending money in buying home, car, etc. This will result in improving the sectors like real estate, automobiles. As demand increases, the sales of these companies increase, thereby providing high returns.
Cyclical stocks have a high beta which simply means that they are highly volatile. These stocks are associated with high risk and high returns as well. They outperform the market during a bull run and underperform the market during a bear phase. If you are a high risk taker and your intention is high returns, you choose to buy these stocks. Extra caution is necessary while choosing to invest in cyclical stocks as nobody can really predict when there will be an economic upturn or downturn. In a nutshell, these stocks either give high returns or give negative returns.
What are Defensive Stocks?
Defensive stocks are not affected by the performance of economy. They provide regular dividend income. These stocks help you to protect your investments during times of recession. If you are a very conservative investor whose main priority is safety, then you can choose to invest in defensive stocks. You cannot expect extraordinary returns from defensive stocks as they simply function as safe haven stocks. If you are a newcomer to the market, you can start investing in these stocks in the initial phase as volatility is less and these stocks won’t give you sleepless nights. Defensive stocks give stable returns at all times irrespective of the economy’s performance.
An investor’s portfolio should have a mix of both cyclical and defensive stocks and only this will help in mitigating risk and reduce loss.
Cyclical vs. Defensive Stock:
|Features||Cyclical Stocks||Defensive Stocks|
|Performance||Dependent on economy||Independent of economy|
|Beta||Higher than 1||Lower than 1|
|Risk||High risk||Low risk|
|Volatility||Highly volatile||Not volatile|
|Example||Auto, Infrastructure||FMCG, utilities|