Take A Little Risk

7/9/2012


The Dow Industrials and Dow Transports have rallied within 3% of this year's respective highs of 13,279.32 and 5,368.93. A move above those levels would represent a bull-market reconfirmation, meaning the June 4 lows of 12,101.46 and 4,847.73 would no longer be significant under the Dow Theory.

Still, the June 4 lows will remain actionable unless both averages close above this year's highs, so subscribers should be prepared to move toward a lower-risk posture. A shift toward defensive, low-volatility stocks often makes sense in such situations. But investors have been migrating toward low-risk stocks for more than a year, and many appear relatively expensive.

How expensive? Consider the table below, which shows valuation statistics based on our Relative Risk scores. Based on five measures of volatility, Relative Risk scores slot the more than 4,400 stocks in our Quadrix universe into five categories.

Low-risk stocks, the one-fifth of stocks with the least volatile returns, have an average trailing price/earnings ratio of 20 — above the norm of 18.5 since 1994. By comparison, High-risk stocks have an average P/E of 17.2 — below the historical norm of 23.3. High-risk stocks have traded at a lower P/E on only 7% of the month-ends since 1994, while Low-risk stocks have traded at a lower P/E on 81% of month-ends.

Stocks with Relative Risk scores of Low and Below Average earn lower-than-normal Quadrix Value scores, while those with scores of High or Above Average earn higher-than-normal Value scores. Stocks with Low and Below Average risk typically earn the best Value scores, but today they earn the worst.

Implications for investors

The lesson for investors is not to load up your portfolio with high-risk stocks. Rather, today's valuation numbers suggest defense-minded investors should not limit their portfolios to low-volatility stocks. Maintaining a broadly diversified portfolio (and using bigger-than-normal cash positions to limit risk) makes more sense.

High-risk stocks earn the worst Overall Quadrix scores, on average, though they rank better than normal because of their atypically high Value scores. Stocks with Below Average Relative Risk scores earn the highest Overall scores, followed closely by those with Average risk. The Monitored List supplement included with this issue includes Relative Risk scores on all our stocks.

LOW-RISK STOCKS UNUSUALLY EXPENSIVE
Based on five measures of volatility and returns, our Relative Risk scores divide stocks into five categories. As shown below, stocks with Relative Risk scores of Low and Below Average trade at a premium to their norms since 1994 based on trailing P/E ratios, while those with scores of Above Average and High trade at a discount.
-------- High --------
--- Above Average ---
----- Average -----
--- Below Average ---
--------- Low ---------
Trailing
P/E Ratio
Value
Score
Trailing
P/E Ratio
Value
Score
Trailing
P/E Ratio
Value
Score
Trailing
P/E Ratio
Value
Score
Trailing
P/E Ratio
Value
Score
Current average
17.2
56
18.3
55
19.0
52
19.4
51
20.0
44
Historical norm
23.3
46
21.6
53
20.2
57
19.3
59
18.5
59
Current as % of norm
74
123
85
103
94
91
100
87
108
75
% of months lower
7
99
11
64
27
13
49
4
81
3

Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com