Where Low Volatility Meets Income

3/14/2016


While investors measure risk in many ways, most associate risk with volatility. With that approach in mind, we calculate Relative Risk scores.

Our Relative Risk scores slot stocks into five risk categories — Low, Below Average, Average, Above Average, and High. We calculate scores for more than 2,600 stocks. Check them out at www.DowTheory.com/Go/Risk.

We don't avoid higher-risk stocks by design, but our analysts do tend to gravitate toward stocks with lower risk. Of the 165 stocks on our Monitored List with the 60 months of history needed to calculate their Relative Risk, 97 (59%) fall into the Low or Below Average categories.

Many investors also see dividends as risk mitigators, as their payouts provide some stability and usable return, even during difficult markets.

Sure, low risk can be boring. But after the excitement the stock market has given us in recent months, doesn't boring sound like fun? As the table below illustrates, stocks with lower risk enjoy stronger fundamentals and have delivered higher total returns.

RISK ANALYSIS
Below we compare the characteristics of more than 2,600 stocks divided into five roughly equal-numbered groups based on their Relative Risk scores. All numbers are averages for stocks in a given risk group.
---------------------- Relative Risk Rating ----------------------
Low
Below
Average
Average
Above
Average
High
Dividend yield (%)
2.7
2.3
1.9
1.6
1.3
Stand. deviation, monthly ret. (%)
6
8
9
12
15
Valuation
Trailing P/E ratio
22.1
20.4
19.5
18.9
15.4
Discount to 5-year average (%)
10
(5)
(8)
(11)
(23)
Trailing price/sales
3.0
2.5
2.0
1.6
1.1
Discount to 5-year average (%)
18
9
(1)
(8)
(34)
Growth
12-month sales (%)
5
5
2
(1)
(7)
12-month oper. EPS (%)
5
4
(2)
(4)
(19)
5-year sales, annualized (%)
7
7
6
6
3
5-year oper. EPS, annualized (%)
10
10
6
7
(2)
Estimated EPS, next 12 months (%)
7
8
9
5
(6)
Est. EPS, next 5 years, annual. (%)
10
13
13
14
16
Total return
3 months (%)
1
(1)
(3)
(6)
(9)
6 months (%)
7
2
(3)
(8)
(19)
12 months (%)
9
(1)
(9)
(16)
(35)
Quadrix scores
Momentum
56
55
50
45
36
Value
45
54
57
59
58
Quality
63
64
58
52
36
Financial Strength
69
66
58
48
34
Earnings Estimates
58
55
49
43
39
Performance
71
60
54
48
37
Overall
60
63
58
53
40
Sectors
% in cyclicals
27
49
59
61
58
% in defensives
23
8
6
5
4
Notes: Averages exclude some outliers.     Standard deviation considers five years of monthly returns.  Quadrix scores are percentile ranks, with 100 the best.

Admittedly, neither a Low Risk Rating nor a solid dividend will guarantee protection against gut-wrenching market moves. The risk characteristics of sectors and industries change over time, as evidenced by master limited partnerships.

For years MLPs delivered excellent returns, bolstered by fat yields, and looked to some investors (not us) as safe as utilities. The Alerian MLP Index has delivered negative returns of 6% so far this year and 36% over the last 12 months — including the effects of the MLPs' fat dividends.


True or false

Think you know all about low-volatility stocks? Test your knowledge with our true/false test. You'll find the answers below.

Low-volatility stocks:
1) pay higher yields.
2) tend to underperform.
3) enjoy superior fundamentals.
4) don't grow as fast as other stocks.
5) tend not to be cyclicals.
6) cost less than riskier stocks.
7) are seeing their profit estimates fall.

What do you know?

Below you'll find answers to the quiz on page 1.

1) TRUE. As the chart on page 1 shows, the lower the volatility, the higher the average yield.

2) FALSE. Like most other types of stocks, low-volatility equities have their ups and downs. At the moment, stocks with Low and Below Average volatility earn higher Quadrix Performance scores and have generated higher total returns than riskier stocks.

3) TRUE. Stocks with Low risk average Overall scores of 60 while those in the Below Average category average 63. Both numbers top averages for the three riskier groups.

4) FALSE. Stocks with Low and Below Average risk average higher scores for Momentum, which mostly measures short-term operating growth, and Quality, which measures long-term growth and some profitability metrics. Looking forward, analysts give higher-risk stocks higher long-term profit-growth targets.

5) TRUE. Of the 10 market sectors, we classified four (consumer discretionary, industrials, materials, and technology) as cyclicals. These four sectors account for 27% of stocks with Low volatility and 49% of those with Below Average volatility. In contrast, the riskier groups contain more than 50% cyclicals. The Low-volatility group features a greater percentage of stocks in defensive sectors (consumer staples, telecom, and utilities). See the table on page 4 for more information.

6) FALSE. Stocks with Low volatility average Quadrix Value scores of 45, the lowest of any volatility category. Lower-risk stocks average higher valuation ratios and are more likely to trade at a premium to historical norms, while higher-risk stocks sport discounts.

7) FALSE. Stocks with lower risk earn higher Earnings Estimates scores than those with higher risk. The Quadrix score rewards stocks when analysts boost profit targets.


Remember MLPs when you look at a stock with a Low or Below Average risk rating. Don't assume the modest volatility will persist long into the future, especially if a stock has become richly valued. By some measures, Low-risk stocks are more expensive than usual. Still, investors looking for easy holds could do worse than focusing on stocks with Low or Below Average risks, reasonable valuations, and decent yields. The table below presents eight such stocks. In the following paragraphs we review three of them.

In the wake of annualized dividend growth of 39% over the last five years, Disney ($98; DIS) pays a yield of 1.5%. Given that the indicated dividend of $1.42 per share represents just 26% of trailing earnings, we see plenty of room for further growth.

Weakness at ESPN has dragged down shares of the entertainment giant, but all four of Disney's business segments delivered at least 8% revenue growth in the December quarter. Studio entertainment paced the divisions with 46% growth, lifted by the staggering success of the latest Star Wars movie, a December release that has topped $2 billion in box-office revenue, third-best in history. Analysts expect per-share profits to rise 13% in fiscal 2016 ending September and an overly conservative 7% next year, with consensus targets trending higher. Disney is a Long-Term Buy.


Shares of Foot Locker ($63; FL) have fallen 6.4% since the company declared January-quarter earnings Feb. 26. Per-share profits rose 16%, topping the consensus, and the company projected double-digit revenue growth for fiscal 2017 (the consensus calls for an 11% gain). The company did report weaker-than-expected same-store sales for the first few weeks of February, while growth in the key basketball market appears to be slowing, factors certainly contributing to the stock's weakness.

The consensus profit target for fiscal 2017 ending January has inched higher since the earnings release, though the fiscal 2018 consensus has eroded. At 13 times the current-year estimate, Foot Locker trades at a 21% discount to the average apparel retailer. Foot Locker is being dropped from the Focus List, but it remains a Buy and Long-Term Buy.


Gilead Sciences ($88; GILD) earns a Quadrix Overall score of 100, topping 90 in five of the six category scores, one of only three U.S.-traded stocks with so many high category scores. The biotech company ini-tiated its dividend last year and yields 2.0%.

Shares of Gilead have trended mostly lower since last summer, hurt by the specter of declining growth from its blockbuster hepatitis C drugs Harvoni and Sovaldi. Concerns include backlash over the drugs' high cost, rival products hitting the market, and possible saturation of the U.S. market. While Gilead won't repeat the profit growth of 61% that it delivered over the last 12 months, current analyst expectations for a profit decline this year and 2% growth in 2017 undervalue the company's other drugs, particularly for treating HIV. Gilead, trading at seven times estimated year-ahead earnings, is a Focus List Buy and a Long-Term Buy.

LOW-VOLATILITY INCOME STOCKS
All eight of the recommended stocks listed below yield at least 1% and sport lower five-year standard deviations than the average stock for which we calculate Relative Risk scores. To identify stocks likely to raise their payouts, we also required at least 9% annualized dividend growth over the last five years, if they've paid out that long.
5-Year
Annual.
Dividend
Growth
(%)
Averge
Monthly
Standard
Deviation
(%)
------------------------------ Quadrix Scores ------------------------------
Company
(Price; Ticker)
Div.
($)
Yield
(%)
Momen-
tum
Value
Quality
Fin'l
Str.
Earns.
Ests.
Perfor-
mance
Overall
Relative
Risk
Alaska Air
($77; ALK)
1.10
1.4
NA
8.3
98
81
98
84
77
58
99
Low
Apple
($101; AAPL)
2.08
2.1
NA
7.3
45
89
98
86
26
34
88
Low
C.H. Robinson
($71; CHRW)
1.72
2.4
9
5.5
80
50
83
44
93
86
87
Low
Comcast
($59; CMCSa)
1.10
1.9
21
5.4
51
66
85
70
32
76
79
Low
Disney ($98; DIS)
1.42
1.5
39
6.0
87
50
94
90
94
38
89
Below
Average
Foot Locker
($63; FL)
1.10
1.8
11
6.5
66
69
94
51
62
53
88
Low
Gilead Sciences
($88; GILD)
1.72
2.0
NA
8.1
98
95
100
93
93
26
100
Below
Average
Lear ($108; LEA)
1.20
1.1
NA
6.9
77
92
92
40
72
47
97
Below
Average
Note: Quadrix scores are percentile ranks, with 100 the best.     NA Not available.

Anatomy of a Relative Risk score

More than 2,600 of the stocks in our Quadrix research universe possess the trading history to generate Relative Risk scores.

To calculate Relative Risk, we draw on five metrics:

• Standard deviation, or the dispersion of monthly returns around the average. The wider the spread of returns, the higher the standard deviation.

• Beta, a measure of how a stock tends to react when the broad market moves. High-beta stocks tend to rise more than the market rises and fall more than the market falls.

• Worst three-month return. We penalize stocks with the lowest lows.

• Performance during down markets.

• Performance during up markets.


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