What makes defensive stocks and cyclical stocks different?

Julie Brownlee, Fsp Invest, 12 May. 2015

Tags: defensive stocks, cyclical stocks, what are defensive stocks, what are cyclical stocks, stocks, investing, stock picking,

When you start researching what stocks to put into your portfolio, you’ll no doubt come across references to defensive stocks and cyclical stocks.

So what do these different classifications mean? And what difference does it make to your stock selections?

Read on to find out…

What’s the difference between defensive stocks and cyclical stocks?

You’ll frequently see analysts categorising stocks into two different camps: Defensive stocks and cyclical stocks.

These categories broadly define how these stocks and their respective businesses perform in different conditions.

How defensive stocks behave

Defensive stocks tend to tick along regardless of what’s going on in the general economy. Economic downturns don’t have a massive impact on their profit growth.

You’ll find defensive stocks in sectors that consumers and businesses need regardless. This includes food retailers and pharmaceutical companies.

‘Sin’ stocks, such as tobacco and alcohol companies also tend to continue seeing stable demand through times of economic down times. This makes these stocks defensive too.

How cyclical stocks behave

Cyclical stocks, on the other hand, tend to see their profits move in tandem with the economy.

When the economy is doing well, so do these companies. Their profits grow strongly during these boom times. When the economy is struggling, these companies struggle too. Their profits dip or even turn into losses.

Cyclical stocks include airlines and car makers. What doesn’t help these companies is they tend to have a lot of fixed costs. This means they have to cover these costs regardless of how well their business is performing.

This means that their profits are very sensitive to changes in sales and demand as dictated by the economy.

What this means to your stock picking

By understanding if a company is a defensive stock or a cyclical stock, you’ll get a better idea of how it will perform depending on how the economy is doing.

A selection of defensive stocks can add some stability to your portfolio during times of economic downturns.

Some investors only invest in cyclical stocks when the economy is starting to show signs of recovery. And when the economy peaks or times start to get tougher, they sell out of these positions.

So there you have it. What makes defensive stocks different from cyclical stocks.

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