Defensive Stocks - Defensive Sectors in Stock Market
29 January, 2024
What are defensive stocks?
Stock investments are always subject to market risk and volatility. However, not all stocks are alike. Some tend to be more volatile than others. The degree of volatility in stocks is governed by numerous factors, ranging from company specific to industry / economy-specific factors.
There are a few industries where businesses are relatively more stable than others. It makes investments in such sectors safer or more defensive than the volatile ones.
How to categorise an industry as 'defensive'?
There are no set criteria that make any industry or sector defensive, yet there are some key parameters via which you can judge the same. The following are such key factors that a defensive share must have:
Stable earnings - Companies that operate in industries where the demand is more need-driven (essentials) and not want-driven usually enjoy stable and predictable revenue. Irrespective of bad times, there are few goods and services which we need to consume or use to ensure a minimal standard of living.
Perennial business - Industries that are influenced by economic or business cycles will tend to go down when there is an unfavourable turn in the economy. For example, consider a cement manufacturer. In times of economic downturn, construction activities tend to take a hit, making your investment subject to such business cycles.
Higher returns - Defensive stocks with a stable business typically have higher cash flows and valuation metrics. It is crucial to invest in companies with higher RoE (return on equity) as it typically means this share can outperform the broader markets.
Having strong and consistent cash flows also ensures that these corporates can cater to all their expenses and investment needs to secure a future growth trajectory.
Sustained dividend payout - Apart from capital gains arising from favourable price changes, dividend payments are another way investors make money. Dividends are the share of profit that the company management decides to distribute among its shareholders.
Dividends are a crucial part of the total shareholder return earned by the investors. Many investors look for companies that can generate regular cash flows for their portfolios. Hence, companies that tend to pay out dividends regularly are considered a safer bet than the ones where dividends are irregular or nil.
Resilience - Historical performance can not guarantee anything for the future. Yet, it is good to check what sectors or industries have shown resilience in their businesses and stock prices during an economic downturn.
The ultimate goal of investing in a defensive share is to lower the overall risk. Hence, it is important to look at the industries that have historically outperformed the market during challenging times.
Industries that are considered defensive
Healthcare industry - Healthcare is a sector that remains unaffected by external factors. Medical treatment is a need-driven demand that has to be taken care of. The healthcare provider people might end up choosing can differ over time, but the overall industry is driven by a necessity of demand, making it a defensive bet.
Utilities - Consumption of utility services, like electricity, water, waste management, etc. is one where you cannot postpone the demand basis economic cycle. These businesses have a relatively stable demand which increases with time due to factors like population. Utility businesses are minimally impacted by economic downturns.
Food - Regular food businesses enjoy a consistent demand over time, as it is necessary for life. Nevertheless, it is crucial to consider the specific type of food company you intend to invest in. Food processors and manufacturers of staple diets like rice, wheat etc., are less affected by economic cycles, whereas businesses like restaurants or cafes can be heavily impacted by the shape of the economy in which they operate.
Information technology - In the Indian markets, shares pertaining to the technology or IT sector are commonly referred to as defensive stocks. In the current era, beyond a point, you can not eliminate the need for technology, be it software or hardware. Owing to this fact, IT companies are also treated as a safer bet against the volatility of the markets.
FMCG sector - The Fast Moving Consumer Goods (FMCG) sector provides a range of products that are a necessity, like personal care products. Even during an economic slowdown, sales of products like soaps and shampoos cannot be eliminated.
Industries that exhibit a significant correlation with the economy are -
Luxury goods
Automobiles
Real estate
High-end apparel
Cement and steel manufacturers
Gaming industry
These industries typically are more volatile than the defensive sectors discussed above.
A fundamental rule of thumb is to evaluate whether the company you intend to invest in is driven by needs or wants. In times of difficulty, individuals tend to reduce discretionary spending, yet they cannot compromise on their essential requirements.
Conclusion
Now you know what the markets refer to as defensive sectors and how you should identify them. It is ideal to keep a diversified investment portfolio with defensive and high-beta stocks, based on your investment goal and risk appetite.
Building the right portfolio starts with opening the right Demat Account. You can open an HDFC Bank Demat Account instantly and embark on your investment journey in a hassle-free manner.
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*Terms and conditions apply. This is an information communication from HDFC Bank and should not be considered as a suggestion for investment. Investments in securities market are subject to market risks, read all the related documents carefully before investing.
