Defensive Stocks: Benefits, Risks, and Top Examples Explained

What Is a Defensive Stock?

Defensive stocks can help you keep your shirt on during times of market volatility. They provide stable earnings and consistent dividends regardless of the state of the economy, as well as smaller declines during stock market downturns. These companies' stocks are often referred to as non-cyclical stocks because their products are in constant demand regardless of the business cycle.

Don't confuse defensive stocks with defense stocks, which belong to companies making weapons, ammunition, and jets.

How Defensive Stocks Strengthen Your Portfolio

Investors may buy more defensive stocks to protect their portfolios during economic downturns or high volatility.

Well-established companies that produce consumer staples, such as Procter & Gamble (PG) and Johnson & Johnson (JNJ), are defensive stocks. These companies have strong cash flows and stable operations with the ability to weather weakening economic conditions, as people still need to buy paper towels and shampoo during recessions. Defensive stocks also pay dividends, which can offset price declines during market downturns.

Defensive stocks can also be found in the healthcare and utilities sectors, among others.

Why would anyone want to own a stock if the economy is getting shaky? Why not just go for a Treasury bill, which offers a "risk-free" return? Defensive stocks generally offer a higher dividend yield than can be found in risk-free investments such as Treasurys, while posing less risk of price decline than regular stocks.

Defensive stocks typically have a beta of less than 1.0, meaning they tend to perform better than the broader market during sell-offs and recessions but they lag the market during expansions. For example, a defensive stock with a beta of 0.5 could be expected to lose only 1% if the market dropped 2% in a week. But if the market rose 2%, a defensive stock with a beta of 0.5 would rise only 1%.

Benefits of Investing in Defensive Stocks

Given their dividend yields, defensive stocks offer the kind of long-term gains associated with equities but without the risk of high-flying growth stocks. This is reflected in their higher Sharpe ratio versus the stock market has as a whole—a solid argument that defensive stocks are objectively better investments than other stocks.

Consider that Warren Buffett became one of the greatest investors of all time in part by focusing on defensive stocks. (His Rule No. 1: Never lose money.) It's not necessary to take excessive risks to beat the market. Limiting losses with defensive stocks can be just as effective.

Potential Downsides of Defensive Stock Investments

On the downside, the low beta of defensive stocks generally lead to smaller gains during bull markets, prompting many poor decisions regarding market timing. Many investors abandon defensive stocks out of frustration with underperformance late in a bull market, precisely when they should be looking to acquire them.

Likewise, investors often turn to defensive stocks after a steep market downturn, though it's often too late. Failed attempts at market timing with defensive stocks can lower investors' returns.

Types and Examples of Defensive Stocks

There are a several types of defensive stocks:

Utilities

Utilities like water, gas, and electric are defensive stocks since they’re always needed. These firms also benefit from lower interest rates in sluggish economies.

Some stocks in this sector include Pacific Gas and Electric (PCG), Excel Energy (XEL), and WEC Energy Group (WEC).

Consumer Staples

Companies that produce or distribute consumer staples, or goods that people tend to buy out of necessity, are defensive. They include food, beverages, hygiene products, tobacco, and certain household items. Consumers will find a way to buy them regardless of economic conditions.

These companies generate steady cash flow and predictable earnings during both strong and weak economies. Their stocks tend to outperform non-defensive or consumer cyclical stocks that sell discretionary products during weak economies while underperforming them in strong economies.

In addition to Procter & Gamble and Johnson & Johnson, mentioned above, defensive stocks in this sector include Walmart (WMT), T-Mobile US (TMUS), and Philip Morris International (PM).

Healthcare

Shares of major pharmaceutical companies and makers of medical devices have historically been considered defensive stocks. There will always be sick people in need of care. However, they aren't as defensive as they once were due to increased competition and regulatory uncertainty.

Defensive stocks in the healthcare sector include pharmaceutical giant GSK (GSK), device maker Baxter International (BAX), and health plan provider Centene (CNC).

Apartment REITs

Apartment real estate investment trusts (REITs) are defensive as people always need homes but avoid those focused on luxury apartments for stable returns. You might also want to avoid office building REITs and industrial park REITs that could see defaults on leases rise when business slows.

Defensive Stock ETFs

Exchange-traded funds offer another alternative to those seeking exposure to defensive stocks, with the added benefit of diversification that reduces single-stock risk. Defensive ETFs can group together stocks from a single or multiple defensive sectors, offering a more efficient and convenient way to gain wider exposure to defensive industries.

Defensive ETFs include Vanguard Consumer Staples ETF (VDC), the Fidelity MSCI Utilities ETF (FUTY), and the Invesco S&P Low Volatility ETF (SPLV). The latter holds shares of low-volatility members of the S&P 500, a de facto defensive stance. Holdings include T-Mobile, Berkshire Hathaway and Mastercard.

The Bottom Line

Defensive stocks offer consistent dividends and stable earnings, making them resilient during economic volatility. They're less susceptible to factors that affect the rest of the stock market, which means they usually come with less downside risk but are also likely to lag the market during bull runs. While they pose lower risk, their potential gains are often smaller during bull markets due to low volatility.

Also referred to as non-cyclical stocks, defensive stocks are generally found in the consumer staple, utility and healthcare sectors. Companies like Procter & Gamble and Coca-Cola exemplify these well-established entities that withstand market downturns.

Investors can gain exposure to these stocks individually or through defensive-focused ETFs. They might consider defensive stocks as part of a diversified portfolio, particularly if they seek to mitigate risk during uncertain economic times.

The comments, opinions, and analyses expressed on Investopedia are for informational purposes online. Read our warranty and liability disclaimer for more info.