Defensive stocks are those companies that provide a safe haven to investors throughout market cycles via paying constant dividends and producing stable quarterly earnings. Defensive stock companies typically produce products that are either vital or addictive to consumers, and therefore tend to weather an economic storm. Conversely, these companies do not necessarily outperform during market boom times because demand tends to remain steady rather than surge during a growing economy.
Choosing to invest in defensive stocks is a way to expose a portfolio to less risk. It is also a strategy to generate steady quarterly income from dividend paying companies and to avoid the psychological and financial pitfalls that accompany market downturns. This is because consumers tend to continue to purchase staple items such as food and beverages for as long as possible, regardless of the economy, but may cutback in other areas, such as entertainment.
Locating defensive stocks is about recognizing the brands that are used in your everyday life. Food stocks such as Kraft, Campbell Soup Company and packaged foods company Con Agra Foods, which produces such items as peanut butter, cooking oil and ketchup, are all considered defensive names.
Since consumers tend to continue to purchase these items regardless of economic conditions, this tendency fuels company sales and leads to steady performance. Other defensive sectors include pharmaceutical names such as medical and consumer products company Johnson & Johnson, in addition to drug company Merck. These companies are defensive because prescription and over-the-counter drugs remain vital necessities throughout economic cycles.
Investing offers no guarantees but selecting stocks defensively has its benefits. Financial experts tout defensive stocks during times of market uncertainty. Jacob Schmidt, chief executive of Schmidt Research Partners, notes in a July 2009 interview on CNBC that during times of economic uncertainty investors should remain invested in defensive stocks. He says look for stocks that pay routine dividends and have little or no debt on their balance sheet. (See References 1)
Consider the risks associated with investing in defensive names. An August 2009 Motley Fool article notes that throughout an economic recession, even defensive companies can lose stock value, although the declines tend to be less severe than what the broader markets experience. (See References 2) However, investors should keep in mind that consumers may also change their habits during market downturns. For instance, consumers may switch from brand name products to generic foods and medicine, and may cut out addictive items such as cigarettes and alcohol altogether. This may cut into sales at some defensive companies.
Losing weight and remaining healthy is something consumers may remain focused on regardless of economic conditions, which qualifies such companies as defensive. One particular weight loss company, Weight Watchers International, generates steady earnings while other sectors are struggling.
In August 2009, Weight Watchers revealed a 26 percent rise in its second quarter earnings. The company also exceeded Wall Street expectations for the quarter, according to Thomson Reuters expectations. (See References 3) And while the stock did come under some pressure between September 2008 and September 2009, Weight Watchers continued to pay investors dividends, which is a quarterly monetary reward to investors for remaining invested in the stock.