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7 Top Characteristics of Defensive Stocks That Protects You From Market Crash

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How do you protect yourself from losing money with defensive stock?

Warren Buffett once said there are 2 Rules of Investing.

Rule 1: Don’t lose money.
Rule 2: Don’t forget Rule 1.

Warren Buffett

Buying great companies is always a good way to invest. But sometimes especially during the market downturn, you need to switch your portfolio to the defensive. That’s when these defensive stocks come into play.

A defensive stock is a great way for you to protect yourself against a stock market crash.

All defensive stocks have some unique characteristics that make them one of the best investments to protect yourself against a market crash.

Finding these special kinds of stocks is actually pretty easy and I am going to show you how in this article.

Let’s Go!

7 Top Characteristics of Defensive Stocks

Defensive stocks have some unique characteristics that make them one of the best investments during times of uncertainty.

Learning and understanding the characteristics of these defensive stocks will allow an investor to identify them during their search for a great investment.

1. Boring Business

Boring businesses are businesses that don’t ever go out of fashion. Businesses such as Fast Moving Consumer Goods (FMCG) products, utilities, etc. are just some examples.

These kinds of businesses don’t usually make your adrenaline rush, or the type of ‘cool’ business people love to talk about.

Almost everyone knows about them, but almost every investor will ‘yawn’ at the mention of these companies.

Simply because, these ‘boring’ businesses are just too normal, and some may even call it the oldies’ investment.

But just because it is the oldies’ investment, it never goes out of fashion which makes it a safe investment heaven even during a market downturn. 

The stock market can be up or down, but you will still need to buy your daily necessities such as toilet paper, groceries, and hygiene products, or use electricity in your home.

Your basic needs, never change even during a market crash.

Boring business that represents our basic ‘needs’ in our life.

2. Stable Business

Stable businesses are businesses that are large blue-chip companies. They usually play a huge role in the country’s economy. These companies have been around for decades, if not centuries.

Companies such as Coca-Cola, and MacDonald’s are examples of such companies. They have been around for decades and contribute greatly to the country’s GDP.

Even during a stock market crash, the investors will have confidence that these stocks will eventually bounce back.

Coca-Cola, for example, has been around since 1886 and has survived the 2 World Wars and many major depressions. Not only has this amazing company survived these major trials, but the company is also still growing after hundreds of years.

Such a company gives investors great confidence that it will survive the next market crash. And these stocks can be a great place for investors to park their money in tough market conditions.

Although they may not give you the kind of returns that some small caps and mid caps do, they protect your downside risk beautifully.

3. Constant Demand

Constant demand is the characteristic of a business that will be in high demand even when the stock market crash.

Business that are the ‘needs’ in your life.

Other than the typical FMCGs and utility stocks, pharmaceutical companies and companies from the healthcare industry are some of the great examples of these companies.

These companies give us one of the best cushions against a market crash. They help to break the fall and protect us from losing our money.

We can choose to buy a new car later, or even stop eating. But if we are sick, we have no choice but to see a doctor to make us well again. Such is the power of these companies with constant demand.

The healthcare industry is one of the best examples of companies with constant demand.

Pharmaceutical companies, on the other hand, is the provider of all medicine we eat, without them doctors won’t be able to treat us.

With the demand for these companies ever increasing, they give one of the best investments even during a bear market.

4. Attractive Dividend Yield Constant Demand

Dividends give an investor a decent return on their investment even during a market downturn. A stock with a nice dividend yield is one of the most important aspects of a defensive stock.

With a good dividend yield, you don’t need to sell your investment to make a return. These stocks will distribute a portion of their earnings back to their shareholders in the form of dividends.

A typical stock with a decent dividend yield will be 3% to 10%. You can also check out my other article on how to find a good dividend stock.

Why do we want it to be at least 3%?

Generally, a risk-free investment such as your government bond will give you a 1% to 2% return on investment. Since a stock investment will have a larger risk, you want to have at least a few percentage points higher than a risk-free investment to justify the extra risk you will be taking.

Why not more than 10%?

This is a great question. Generally, it is ‘OK’ to buy a stock that gives a more than 10% dividend. The price of the company might have a drop in price due to panic sales in the industry, while the fundamentals of the company are still sound. Which can lead to a nice high level of dividend yield.

But sometimes, an extraordinarily high level of dividend or high dividend payout ratio would mean that something might be wrong with the company you are buying. When it is too good to be true, as an investor, you have to be cautious.

5. Low Volatility

Defensive stocks are much lower in volatility compared to the common stocks found in the stock market. They are not the 10-baggers or even the 2-baggers of the stock market.

They are not the ‘darling’ of the wall street.

During a bull market, these defensive stocks aren’t the types of stocks that raise the most. They may raise together with the economy of the country or the industry. But you don’t usually see a 10% increase in price within 1 day.

During a bear market, these defensive stocks may drop in price by 10% to 30% but seldom do you see them drop by more than 50%.

They have the highest resilience against price fluctuation.

Because of the low volatility, some people especially the speculators or short term traders call them boring, and institutional investors usually ignore them.

But this is the exact reason why these defensive stocks are the best investment during a stock market crash.

With the absence of short-term traders and speculators, the price of the stock will be minimally impacted during times of fear when everyone is selling their investment.

During a market crash, some stocks, especially tech companies can drop 90% in price, which can be pretty bad for the heart.

6. Low P/E and P/B

Low P/E and low P/B are some of the most obvious characteristics of a defensive stock. These ratios are the metrics used by most investors to see if a company is cheap or expensive.

Since, defensive stocks are usually not brought by short-term traders, speculators, or even most fund managers on wall street. The current price of the stock is usually quite consistent with the value of the company.

In other words, the price of the stock usually considers cheap, compared to the general market. The ‘cheapness’ of a stock is usually measured by the P/E and the P/B of the stock which is a part of the fundamental analysis performed by smart investors.

What is P/E?

P/E is the Price-to-Earning Ratio, it is the relation between the current price of the stock and the earnings the stock makes in the past 12 months.

A higher P/E means that you are paying more for each dollar earned by the stock. A lower P/E means that you are paying less for each dollar earned by the stock.

To understand if it is a high or a low P/E you have to know what is the historical P/E of the stock. And compare it with its historical data and the data of its similar industry.

Example:

Company ABC has a P/E ratio of 10. It means that you are paying 10 dollars for each dollar earned by the company.

  • Current Price (P): $10 per share
  • Annual Net Income (E): $1 per share
  • P/E ratio = 10/1 = 10

What is P/B?

P/B is the Price-to-Book Ratio, it is the relation between the current price of the stock and how much the company is worth. This does not include the intangible assets of the company, such as the brand, intellectual properties, etc. Only the physical asset of the company is included in this calculation of the book value.

The book value is calculated from the equity of the company, which is calculated by subtracting the total asset to the total liabilities of the company.

A P/B of 1.0 means you are paying $1 for every $1 book value of the company.

A P/B of more than 1.0 means that you are paying more for each dollar worth of the company. You are basically paying a premium for its price. The stock is overvalued.

A P/B of less than 1.0 means that you are paying less for each dollar worth of the company. You are basically paying a discount on its price. The stock is undervalued.

Example:

Company ABC has a P/B ratio of 0.9 means that you are paying 0.9 dollars for each dollar of the book value of the company.

  • Current Price (P): $0.9
  • Book Value (B): $1
  • P/B ratio = 0.9/1 = 0.9

Read Also: How to prepare for a market crash by age?

7. Low Beta

The beta (β) is a measurement of its volatility commonly used to measure an investment (i.e. a stock). Beta (β) is the measurement of the systematic risk of individual stocks compared with the returns of the entire market.

A company with a higher beta has greater risk and also greater expected returns.

A company with a lower beta will have a lower risk and also lower expected returns.

The beta coefficient can be explained as follow:

  • β >1, higher volatility than the general market
  • β =1, the same volatility as the general market
  • β <1 but more than 0, lower volatility than the general market
  • β =0, uncorrelated to the general market
  • β <0, negatively correlated to the general market

Defensive stock are usually stock with β <1 but more than 0 which gives them the characteristics of lower volatility than the general market.

Such stocks may not be the ‘darling’ of wall street due to their lack of volatility, but they can be one of the best investments to protect against a market crash.

Read Also: Advantages of Small Investors, Fund Managers Don’t Want You to Know

Is Defensive Stock For You?

Smart investors will always have a few defensive stocks in their portfolio. These stocks become especially important when the market is overvalued which shows warning signs of a stock market crash.

If you want to protect yourself against a market downturn, defensive stocks are one of the best places to park your money.

These stocks together with their unique characteristics ensure that you will be much less likely to lose half of your investment capital in the next stock market crash.

A 50% loss in your portfolio can be really painful, and I don’t really want any of my readers to experience that horror.

Thus, protect your investment with these characteristics of a defensive stock.

Here are the 7 characteristics of defensive stocks:

  1. Boring Business
  2. Stable Business Model
  3. Consistent Demand
  4. Attractive Dividend Yields
  5. Low Volatility 
  6. Low P/E or P/B
  7. Low Beta

Next, we shall look into some other articles on what to do during a stock market crash.

But before that, you can also check out some of my other articles on investing.

Knowledge

Knowledge is what differentiates a successful investor from a gambler. Successful investors like Warren Buffet are successful because they have the right knowledge to make the right decision to buy or sell a stock.

Combined with the right investing knowledge and the advantages of being young. You have the potential of getting a nice profit from your investment.

Successful investors like Warren Buffett read approx 500 pages a day.

Knowledge of investment can be learned from books or articles like this one. Reading can only make you wiser and smarter so that you too may be able to make the right decision in your investment.

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Founder & Financial Writer at Income Buddies | Website | Posts by Author

Antony C. is a dividend investor with over 15+ years of investing experience. He’s also the book author of “Start Small, Dream Big“, certified PMP® holder and founder of IncomeBuddies.com (IB). At IB, he share his personal journey and expertise on growing passive income through dividend investing and building online business. Antony has been featured in global news outlet including Yahoo Finance, Nasdaq and Non Fiction Author Association (NFAA).

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