Defensive Stock

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DEFINITION of 'Defensive Stock'

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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RELATED FAQS
  1. At what stage of the economic cycle should I invest in the utilities sector?

    Later stages of the economic cycle, as the economy moves from expansion to recession, are the best time to invest in the ... Read Full Answer >>
  2. What economic indicators should an investor in the aerospace sector consider?

    The economic indicators that investors in the aerospace sector should consider are economic growth, interest rates and inflation. ... Read Full Answer >>
  3. What is the difference between cyclical and non-cyclical stocks?

    The difference between a cyclical stock and a non-cyclical stock is that a cyclical stock is highly correlated with movements ... Read Full Answer >>
  4. Why do telecommunication stocks pay above-average dividends?

    Investors seeking high dividends tend to gravitate toward telecommunication stocks, and for good reason. While the average ... Read Full Answer >>
  5. What is the downside of investing in the utility sector?

    There several disadvantages associated with investing in the utility sector. Utility stock prices are unlikely to fluctuate, ... Read Full Answer >>
  6. What are defensive stocks?

    The term defensive stocks is synonymous to non-cyclical stocks, or companies whose business performance and sales are not ... Read Full Answer >>

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