All about stock picking:
Investors should know their goals, their risk capacity and have a good knowledge about the companies they choose to invest. Investing has to be done after careful research or else one may lose money. Depending on one’s financial goals, stocks have to be cherry picked. As there are 2 types of stocks namely cyclical and defensive, one has to choose stocks according to one’s need. Cyclical stocks are those that give high returns but are associated with high risk as well whereas defensive stocks give stable returns irrespective of the market condition. Cyclical stocks don’t perform well when the market is down. If safety is your priority, choose defensive stocks. If high returns are your priority and you can afford to take risk as well, go for cyclical stocks. To offset your risk, you should have both cyclical and defensive stocks in your portfolio. This will put you in a win-win situation. You can get high returns from cyclical stocks when the economy is doing well and you can get stable returns from defensive stocks when the economy is witnessing a downtrend. Let us learn about defensive stocks in this article.
What are defensive stocks?
One should have a proper knowledge about investing before buying stocks. Investment motive varies from person to person and hence the investment avenue also varies. Whether you choose to invest in shares, bonds or mutual funds, a specific investment strategy has to be in place. If you invest in equity, you should have a clear picture of what defensive stocks are and how you can get benefitted by investing in these stocks. Defensive stocks are also called as non cyclical stocks. Cyclical stocks tend to outperform the market when the economy is in good shape and underperform when the economy faces a downturn. On the other hand, defensive stocks give stable returns all the time. Picking of quality stocks that suit your investment objective is very essential. You have to regularly have a watch over your portfolio to know which stocks are outperforming and which are underperforming. Based on this, you can either add particular stocks or remove stocks to get better returns.
When should one choose to invest in defensive stocks?
- When you don’t have a proper understanding of the market condition
- If you are a risk averse investor
- If you prefer regular dividend income
- If the markets are volatile
Let us know in depth about the characteristics of defensive stocks. These stocks/companies manage to put up a good show even during times of recession. We will understand this using a simple example. Soap is a very basic commodity that is used by all of us on a daily basis. Whether the economy does well or not, demand for soap remains the same. The companies making soap, paste, etc. keep providing stable returns as they are not drastically affected by the economy’s performance. As people are habituated to these stocks and need them on a day to day basis, the sales of these products remain stable irrespective of the business cycles and macroeconomic condition. These are inelastic goods which mean that a change in price of these stocks will not affect the demand of these goods. But if you take the example of car, if the price of car increases drastically, the demand for cars will reduce. Car or automobiles are cyclical stocks whose performance is purely dependent on the performance of the economy or spending capacity of people.
Defensive stocks meaning and characteristics:
- Stocks that are into uniform/monotonous business like FMCG, healthcare, utilities, etc.
- Have beta lower than 1
- Less volatile
- Don’t generate high returns
- Protect your investments during recession
- Provide regular dividend
Beta indicates the stock’s vulnerability or risk factor. Defensive stocks have beta lesser than 1 which implies that they are less volatile. A conservative investor who is afraid of taking risk can invest in defensive stocks that will give stable returns. Some examples of Defensive stocks are gas, electricity, FMCG, etc.