What Are Defensive Stocks?
What are defensive stocks? They are stocks that are safe in a bear market. When we play a sport defensively, we play it safe. The same applies to the stock market. During a period of economic uncertainty, investors seek out safe and defensive stocks. During a bear market, they offer modest gains in terms of capital and dividends. In today’s market conditions, they might be an interesting option. Until the markets recover from the war between Russia and Ukraine and chain supply issues, market volatility remains a constant risk. Defensive stocks are also welcomed during periods of high inflation. In my opinion, they should be considered for the remaining of this year. In this article, we will take a look at their characteristics and we will give a few examples of stocks and ETFs to look for.
Defensive Stocks Characteristics
As we established earlier, defensive stocks have certain qualities that make them an interesting investment during a period of uncertainty. What are these qualities?
First, defensive stocks provide safety in their demand and earnings when other stocks are struggling. During a recession or a period of high inflation, demand remains constant. In turn, this doesn’t impact quarterly earnings negatively. Other stocks will struggle to keep their investors on the boat with declining sales and below-average earnings performance.
Defensive stocks will keep growing modestly. However, when the economy goes back to normal, they tend to underperform major indexes. It is wise to allocate funds accordingly during economic growth and economic uncertainty.
Second, defensive stocks are known to provide reliable dividends. Investors can rely on quarterly cash or DRIP distributions in their pockets. In some cases, when the results are better than anticipated, dividends can be increased. Now, let’s talk specifics. Which stocks are considered defensive?
The stock market contains 11 sectors. However, not every sector is considered defensive. If we look at the tech sector, it underperforms during economic uncertainty. This year is a great example.
Less people will go purchase the latest gadget or the new iPhone 13 Pro Max. During this period, defensive stocks have constant demand. They are also called noncyclical because they are often not correlated to the business cycles. Defensive sectors include the following.
Utilities: Utility stocks are needed year-round, independent of weather, inflation or wars. They include water, gas, electricity and gas.
Consumer Staples: Consumer staples are household items needed year-round. Good examples are food, hygiene products, beverages and most things found in a house.
Healthcare: Health is one of the most important factors that determine our quality of life. Hence, pharmaceutical products, as well as medical equipment, maintain a constant demand during periods of economic uncertainty.
In this section, we will take a look at stocks in every sector mentioned above. We will try to touch as many industries as possible.
Duke Energy (NYSE: DUK): Duke Energy is an electricity and gas producer in the US that provides its services to over 7M Americans across North Carolina, South Carolina, Florida, Indiana, Ohio and Kentucky. The company generates its resources from coal, natural gas, oil and nuclear power. A transition to renewable energies would probably slash some costs and benefit the environment. Revenues have been steadily increasing over the last decade. With a 3.70% annual dividend yield, Duke Energy is a good investment when searching for defensive stocks.
Brookfield Infrastructure Partners (NYSE: BIP): BIP acquires and manages assets in different industries. It builds its portfolio and rewards its investors based on performance. BIP’s infrastructures include utilities, transportation, energy and other types of infrastructures. Historically, its acquisitions have paid up both to the company and to investors. Its 3.80% dividend yield is a solid payday for investors.
American Water Works (NYSE: AWK): The final stock in this section operates in water distribution and wastewater. It’s the largest public company in its field. It provides water to homeowners and the military. This translates to over 14M people across 24 states. It is currently investing to expand its operations, which might explain its poor performance YTD. AWK’s dividend yield is also lower than the other stocks in this section at only 1.76%.
Consumer Staples Stocks
Proctor & Gamble (NYSE: PG): PG is the perfect defensive stock. It sells virtually everything found in an American household such as laundry detergent, hygiene products, diapers, tissues, razor blades and many more.
The main benefit is PG doesn’t need to own any infrastructure to distribute its products. Stores like Walmart and Costco want PG’s products on their shelves because they sell very well year-round. Furthermore, it has a very respectable annual dividend yield of 2.57%.
Costco (NASDAQ: COST): If you want to buy in bulk or astronomical sizes, you shop at Costco. The company operates in the US, Canada, Mexico, Japan, the UK, South Korea, Taiwan, Australia, Spain, China, France and Iceland for a total of 828 stores. Virtually anything can be bought at Costco. Its revenue also grew almost 14% YoY, which is impressive for a defensive stock. Lastly, Costco’s annual dividend yield is only 0.75%, but its growth complements a small dividend distribution.
Walmart (NYSE: WMT): According to Fortune, Walmart is the world’s largest employer. No wonder with over 10,000 stores across 24 countries and an excellent e-commerce website. Walmart is reliable and provides essential goods for everyone. Its 1.80% dividend yield is also respectable.
McKesson (NYSE: MCK): Since 2018, McKesson’s growth has been impressive. This year is no exception. Its healthcare supply management seems unphased, unlike other industries. It also supplies specialty care, pharmacy products and biopharma support. McKesson is a well-diversified healthcare stock that has more room to grow. Its growth more than justifies its slim 0.58% dividend yield.
CVS Health (NYSE: CVS): CVS is an American pharmacy chain that operates almost 10,000 locations across 49 states, including DC and Puerto Rico. Despite the competition from big retailers such as Walmart, CVS continued its growth through acquisitions and resilience. Its growth is much more modest, but its dividend is stronger at 2.31%.
Many ETFs can suit customers looking for a defensive approach during an economic slowdown. They incorporate stocks and sectors we mentioned today as well as other riskier assets. Asset managers have no shortage of stocks to choose from. Small/mid/large-cap stocks can all fit into the defensive description. ETFs also distribute dividends in cash or as a DRIP.
Vanguard Consumer Staples Index Fund ETF (NYSEARCA: VDC): Vanguard’s ETF comprises 103 consumer staples stocks. Top holdings are PG, Coca-Cola, Pepsi, Costco, Walmart and cigarette companies.
Invesco S&P 500 Low Volatility ETF (NYSEARCA: SPLV): Invesco’s ETF tracks the least volatile companies in the S&P 500. Its top holdings include J&J, Verizon, Pepsi, Coca-Cola and Hershey. Utilities, consumer staples and healthcare are almost 66% of the entire fund.
JPMorgan US Value Factor ETF (NYSEARCA: JVAL): JPMorgan’s top holdings include a mix of tech, consumer staples and health stocks. It’s an interesting mix since tech stocks don’t perform well compared to defensive stocks during a bear market.
Now You Know What Defensive Stocks Are
To conclude, defensive stocks are a great option during times of economic uncertainty. The stock market usually performs poorly and defensive stocks become a viable option due to their stable demand and dividend distributions. During a bull market, defensive stocks usually underperform their peers.
The main defensive sectors are utilities, consumer staples and healthcare. Consumers require these goods and services on a daily basis as they are essential to everyday life. When times are hard, forget growth stocks and focus on reliable defensive stocks.