Defensive Stock definition & tips to select a profitable company to invest in
Defensive stock is a very favorite term of investors as it ensures stable earnings. Here, we are going to tell our readers the complete meaning of this term and how to choose a best stock company to get higher profits.
Meaning of defensive stock
Defensive stock refers to the shares of those companies which have very less scope of decrease in returns. Thus stable earnings are expected from them. The shares of such companies do not show bad performance even in times of recession. In simple words, defensive stocks are those stocks which remain stable even under difficult economic circumstances. That's why; they are also called as 'non-cyclical stock' because they are highly correlated with economic conditions and business cycles.
Such companies are believed to be defensive because the product manufactured by them always remains in demand. Thus their shares are also stable even in poor times. Such products include tobacco, food products, oil and other utility items. People need these things all the times, no matter that what is the condition of market. However, the performance of such companies is a little low during the phase of expansion. How to select a good defensive stock company
A passive investor looking for a portfolio of strong companies for long term investment can follow these guidelines to choose defensive stock companies.
1. Size of the organization:
Size of the enterprise is a major aspect to select a good company. In investment scenario, a small company generally tends to greater fluctuations in earnings. Thus, its better to invest in a company which has annual turnover of approx. Rs. 23,000 million in case of industrial company and Rs. 11,500 million in case of public utility company.
2. Record of Dividend payment:
Companies which are paying dividend on its common stock for at least 20 years can provide you better assurance of payment of dividend in future.
3. Moderate ratio of Price to Earnings:
The current price of a stock should not be more than 15 times of its average earnings for last 3 consecutive years. This is a good factor for an ideal portfolio as it provides security and safety against overpayment of a security.
4. Strong financial condition:
Long term debt should not be more than working capital, so as to ensure sufficiently strong financial condition. A stock should have a minimum current ratio of 2. The debt for public utilities should not be more than twice the stock equity at book value.
5. Growth in earnings:
Be ensured that the profits of the company can compete with the inflation. For this purpose, net income of the company should be increasing by 1/3 or more in per share basis for at least last ten years using averages of first and last 3 years.
6. Stability of earnings:
The company must not be bearing loss over last 10 years. Those companies are believed to be more stable on the whole which are able to maintain at least some level of earnings through each financial year.