- What are defensive stocks?
- Defensive vs. cyclical stocks
- Top UK defensive stocks
- British American Tobacco
- Reckitt Benckiser Group
- Imperial Brands
- Tate & Lyle
- Top defensive sectors
- 1. Consumer staples
- 2. Utilities
- 3. Real Estate
- 4. Healthcare
- Investing in international defensive stocks
- When is the best time to invest in defensive stocks?
Whenever the economy or stock market enters into a state of heightened volatility, the popularity of UK defensive stocks increases. Investing in these businesses is often viewed as a safe haven against rapidly fluctuating stock prices.
But what exactly are they? And why does this strategy help protect wealth? Let’s dig in.
What are defensive stocks?
A defensive stock is a general term to describe any equity whose underlying business generates a reliable cash flow even during times of economic uncertainty. These are generally mature industry leaders offering products or services always in demand.
Defensive companies aren’t known for delivering exceptional growth. And during bull markets, they typically underperform benchmark indexes like the FTSE 250 or S&P 500. But since earnings have a habit of consistently pouring in, they regain favour in bear markets, even more so among income investors who seek reliable and consistent dividends.
Defensive vs. cyclical stocks
The opposite of defensive stocks is cyclical stocks. These businesses are highly susceptible to external factors beyond their control, such as the macroeconomic environment. As a result, owning cyclical companies can be a bit of a roller-coaster ride, surging when times are good and plummeting when things turn sour.
Typically, cyclical businesses offer products or services that aren’t always in fashion due to fluctuations in supply and demand.
For example, consumer discretionary retailers tend to suffer during economic uncertainty as households seek to cut unnecessary spending. Alternatively, if the price of a metal plummets due to oversupply, mining companies can struggle to deliver impressive earnings.
Top UK defensive stocks
Here are some of the top defensive stocks in the UK by market cap.
|Unilever (LSE:ULVR)||One of the larger consumer staples retailers in the world offering food, personal care, and home care products|
|British American Tobacco (LSE:BATS)||One of the largest cigarette companies in the world, offering a wide range of tobacco-based products|
|Reckitt Benckiser Group (LSE:RKT)||Offers a wide range of hygiene and consumer healthcare products that can be found in most supermarkets globally|
|Imperial Brands (LSE:IMB)||The sixth-largest tobacco business worldwide diversifying into vapour and heated tobacco products|
|Tate & Lyle (LSE:TATE)||One of the oldest British ingredient supplier companies for food and beverages|
Unilever Plc is a fast-moving consumer goods company that offers food, personal care, and home care products. Since being established in 1894, the firm has expanded into one of the largest branded consumer staple businesses within the United Kingdom.
Its products can be found in almost all major supermarkets and include items such as Hellmann’s mayonnaise, Ben & Jerries ice cream, Dove shampoo, Peril washing up liquid, and Cif surface cleaner, among hundreds of other brands.
British American Tobacco
British American Tobacco is the third-largest cigarette company in the world. Based in London, the company manufactures and sells a wide range of tobacco-based products, including combustible tobacco, loose tobacco, and oral nicotine.
With healthcare scrutiny its industry rising, management has been ramping up internal investments into less harmful product lines, namely electronic cigarettes and heated tobacco. Today, it hosts a wide portfolio of brands, including Dunhill, Kent, Pall Mall, and Rothmans, among others.
Reckitt Benckiser Group
Reckitt Benckiser is a global consumer goods enterprise targeting the hygiene, consumer healthcare, and nutrition market sectors. It’s worth noting that the majority of its brands are found in the first two areas, which are typically underserved by its competitors, like Unilever.
Its products can be found in supermarkets worldwide, including brands such as Air Wick, Finish, Woolite, Clearasil, Durex, and Veet.
Imperial Brands is the sixth-largest tobacco company globally, with headquarters in Bristol. It offers a range of tobacco-based products such as cigarettes, loose tobacco, rolling papers, and cigars. After some industry consolidation, the group now owns and operates multiple globally recognised brands, including Winston, West, Davidoff, Gauloises, and Rizla.
In recent years, the firm has been focused on expanding its next generation product line through its newly introduced Pluze heated tobacco solution and Blu vaporisation devices.
Tate & Lyle
Tate & Lyle is a food producer based in the UK that provides ingredients for beverages, various soups, sauces, and food dressings. One of its most famous brands, Lyle’s Golden Syrup, was sold off in 2010 as part of management’s strategy to veer away from sugar-based products.
Today it focuses on a wide range of alternative products that can be found in pre-prepared meals or bought individually from supermarkets, including soups, stews, broths, mayonnaise, yoghurt, ice cream, soft drinks, juice, and coffee and tea.
Top defensive sectors
There are quite a few defensive sectors for UK investors to choose from. So, let’s go through the four most popular.
1. Consumer staples
Regardless of what the economy might be doing, there are some things that we simply can’t live without. As such, consumer staples products are often the last to be reduced or eliminated from a shopping list. This includes food, drinks, hygiene, and for some, tobacco.
Branded staples products can experience a reduction in sales volume. But this is typically offset by raising prices. Meanwhile, supermarkets and other staples retailers can sometimes see a surge in overall volumes as households stock up on essentials in fear of worsening economic conditions.
The economy may be in tatters, but without water, electricity, or gas, businesses and households cease to function. Consumption can drop as individuals seek to cut usage, but this tends to have a negligible impact on the industry.
3. Real Estate
Thanks to the creation of real estate investment trusts, it’s become easy for investors to tap into the property market without needing to take out a mortgage. But the real estate industry is quite vast, containing many different sub-sectors for various property types, each of which behaves differently during economic turmoil.
- Households and apartments – People need shelter. Subsequently, the default rates on rents and mortgages tend to remain low as consumers cut discretionary spending to meet their monthly rent.
- Offices and retail parks – With consumer spending dropping, businesses, especially front-end discretionary retail, can struggle financially. As such, office spaces and retail park lots can end up becoming vacant. And finding a suitable replacement tenant during an economic wobble can be difficult. As such, these types of properties end up losing value.
- Warehouses, factories, and hospitals – Industrial properties are often at the heart of most operations and are typically the last to go should a downsizing occur. But if tenants are large established enterprises, the default rate typically remains low, maintaining rental cash flow and property values.
Even if the cost of living goes up, patients still need access to medicine and healthcare facilities, regardless of price. As such big pharma, hospitals, and other healthcare services businesses tend to continue chugging along nicely.
The exception is young biotech. As these companies often don’t have a meaningful revenue stream, they remain dependent on external financing, whose availability tends to decline while the cost of borrowing increases during periods of economic uncertainty.
Investing in international defensive stocks
The process of investing in defensive stocks outside the UK is nearly identical. However, there are a few extra parameters to consider.
With international stocks being listed on foreign exchanges in different currencies, any share price returns or dividends received could be adversely impacted in pound sterling terms. And when economies are wobbling, volatility in exchange rates is not uncommon.
Another factor to think about is industry regulation. Much like in the UK, sectors like healthcare, utilities, and real estate are all subject to slightly different regulatory requirements in different countries. As such, a valid British investment thesis may be invalid in international markets like the US.
When is the best time to invest in defensive stocks?
As previously mentioned, investors often rush towards defensive stocks throughout every period of economic instability. By staying in the stock market versus moving to bonds, gold, or UK gilts, investors can still generate relatively low-risk returns through dividends from this class of equities.
Unfortunately, this is where a timing problem emerges.
When a bull market starts to ramp up, defensive stocks often lose favour due to their underperformance, and investors migrate back towards cyclical growth. This causes the share prices of these mature businesses to drop, causing more investors to move on.
Yet, despite the slow downward trajectory of the defensive stocks in this situation, the underlying businesses are still chugging along. With cash flow supporting dividends, the yield rises. This actually creates buying opportunities for value investors. And it’s a tactic that Warren Buffett is constantly deploying.
However, eventually, catastrophe will hit again. And as investors decide defensive stocks are now the best place to be, share prices rise, pushing the yield down.
Subsequently, anyone that’s late to the migration ends up owning overvalued defensive shares with a low dividend yield. They won’t benefit as much from the income returns during the economic turmoil. And in some circumstances, when growth stocks regain favour, they could actually lose money as their overvalued stock drops.
With that in mind, the best time to buy defensive shares is often during a bull market when they’re cheap and sell during a bear market when they’re expensive – the complete opposite of what most emotionally-driven investors do.