An article published in The Australian Financial Review over the weekend raised an interesting question: what really is a defensive stock and are they really the right option?
Traditionally, Australia's blue chip companies, such as the big four banks, Telstra (ASX: TLS) or supermarket giants Woolworths (ASX: WOW) and Wesfarmers (ASX: WES) have been recognised as defensive stocks, in that they are seen as 'safe' places to put your money – but are they really?
In light of globally low interest rates and economic turmoil (still in the aftermath of the GFC), shares in each of the companies mentioned above have rallied in value substantially as investors have sought out higher income streams from dividends than those they would otherwise recognise from term deposits. However, the prices of many of these companies have become significantly overvalued suggesting that, over time, they will likely fall in value and reverse many of the gains recognised from dividends paid.
So just how 'safe' are these 'defensive' stocks? Sure, the companies might have established themselves as powerhouses in their respective industries and they may be amongst the safest in the economy from becoming obsolete or going bankrupt. As highlighted in Philip Baker's article however, the nature of a defensive stock "really boils down to the price you pay."
For instance, the banks would have been considered defensive options when they were at their lowest value around May 2012, but that may not be the case if you were to buy them at today's valuation. That is, it may not represent a 'safe' option in that your investment could just as likely fall in value when interest rates inevitably increase and high dividend yields lose some of their appeal.
Foolish takeaway
Whilst there is certainly a higher level of risk involved when investing in growth stocks, the upside also seems much more appealing. There are quality companies still sitting at very reasonable prices with plenty of growth potential and many could argue that, in today's economic environment, these may be more defensive options.
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Motley Fool contributor Ryan Newman does not have a financial interest in any of the mentioned companies.
