Defensive Stock

What is a 'Defensive Stock'

A defensive stock is a stock that provides a constant dividend and stable earnings regardless of the state of the overall stock market.

This is not to be confused with a "defense stock", which refers to stock in companies which manufacture things like weapons, ammunition and fighter jets.

BREAKING DOWN 'Defensive Stock'

Defensive stocks remain stable during the various phases of the business cycle. During recessions they tend to perform better than the market; however, during an expansion phase it performs below the market. Betas of defensive stocks are less than one.

To illustrate this phenomenon, consider a stock with a beta of 0.5. If the market is expected to drop 15%, and the existing risk-free rate is 3%, a defensive stock will only drop 9% (0.5*(-15%-3%)). On the other hand, if the market is expected to increase 15%, with a risk-free rate of 3%, a defensive stock will only increase 6% (0.5*(15%-3%)).

The utility industry is an example of defensive stocks because during all phases of the business cycle, people need gas and electricity. Many active investors will invest in defensive stocks if a market downturn is expected. However, if the market is expected to prosper, active investors will often choose stocks with higher betas in an attempt to maximize return.

Also known as a "non-cyclical stock" because it is not highly correlated with the business cycle.

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