Has Low-Volatility Bubble Popped?

12/5/2016


Historically, investors have been willing to pay up for shares of the fastest-growing companies. That's not what they're paying up for these days.

Since 1994, stocks in the riskiest quintile for Relative Risk score (blend of five volatility metrics), beta (volatility relative to the market), and standard deviation (dispersion of returns around the average) have averaged higher growth rates and price/earnings ratios than other stocks.

All that changed in the last couple years, however, as safety-seeking investors bid up low-volatility stocks. Even now, with broad market indexes near all-time highs, investors continue to put a premium on safety.

In recent months, we've written several times on the low-volatility bubble, the inflation of valuations for stocks perceived as low risk. A combination of high valuations, weak fundamentals, and recent share-price underperformance suggests the bubble has popped.

The statistics in the charts below and above focus on quintiles (fifths) of the S&P 1500 Index, broken down based on our proprietary Relative Risk score (www.DowTheory.com/Go/Risk). Quintiles determined by other measures of volatility show mostly similar trends.


NOT YOUR FATHER'S LOW-VOLATILITY STOCKS

For most of the last 20-plus years, stocks with the lowest risk tended to have the lowest profit-growth potential, with slightly higher-than-average Quadrix Overall scores and decent Value scores. Market dynamics have changed in recent years, as low-volatility stocks now earn weaker Overall scores than stocks with modest volatility and are more expensive than other stocks.

One thing hasn't changed — low-volatility stocks still have low profit-growth expectations. The numbers above consider S&P 1500 Index stocks broken into quintiles based on our Relative Risk score; quintiles determined by beta and standard deviation show similar trends.

Low-volatility stocks have Overall Quadrix scores lower than stocks of moderate risk, as well as weaker than their own historical norms. Not all low-volatility stocks earn poor scores. However, for most of the last two years, stocks with moderate risk have averaged higher Overall ranks and more appealing valuations.

Those lower scores don't mean we've abandoned low-volatility stocks, but we don't buy them just because of their low volatility. We consider the merits of low-volatility stocks through the same lens as any other stocks, looking for attractively valued growers.

Th table below lists nine A-rated stocks with either Low or Below Average risk. All nine have solid Overall and Value scores and decent growth prospects, bucking the trend for low-volatility stocks. Three are reviewed below:

Biotechnology stocks have a reputation for wild fluctuations. But Biogen's ($294; BIIB) beta, which measures a stock's volatility compared to the overall market, ranks among the lowest 30% in the S&P 500 Index and is the biotech industry's lowest. The shares have risen 1% in the past 12 months despite slipping in late November after Eli Lilly ($67; LLY) dropped plans to seek regulatory approval for an experimental Alzheimer's disease treatment that failed a late-stage trial. The drug was designed to clear patches of a protein called beta amyloid that form on the brain. Beta amyloid is believed to cause the disease.

Biogen is developing a drug that takes a similar approach to Lilly's version. But Biogen's treatment involves a different molecule that aims to clear a different form of beta amyloid. Biogen plans to release new data on the drug in early December. Even before Lilly's disappointing results, expectations for Biogen's treatment were muted, with analysts putting the chances of success at less than 50%. Biogen is a Buy and a Long-Term Buy.


Disney ($99; DIS) grew per-share profits 17% in fiscal 2016 ended September on 6% higher revenue. Yet its shares have slumped 21% over the past 12 months as investors continue to fret over the future of ESPN, which represents about a quarter of the company's revenue. ESPN's advertising sales fell 13% last quarter, and Disney said ad sales could continue to decline in the December quarter because of the timing of college football bowl games.

Amazon.com ($751; AMZN) could emerge as yet another threat to ESPN's dominance. In a possible extension of its Amazon Prime service, the company has reportedly discussed streaming professional sporting events online.

In the wake of its problems, Disney's stock looks unusually cheap, earning a Value rank of 77, up from 36 a year ago. Management remains upbeat on ESPN, insisting that its long-term growth story remains intact. Disney also expects companywide profit growth to continue in fiscal 2017 and accelerate in fiscal 2018. Disney, yielding 1.4%, is a Long-Term Buy.


Laboratory Corp. of America ($126; LH) qualifies as one of the least-volatile stocks in our research universe, reflected by its Relative Risk score of Low. The stock trades 11% off its 52-week high, following a mixed September-quarter report. Testing volumes were weak in the quarter, though revenue per requisition rose 4%. Management's decision to exit low-margin accounts has limited recent growth but should boost future profitability.

LabCorp's per-share profits are projected to rise 9% in the December quarter and 10% in 2017, ahead of the S&P 500's projected growth of 6% this quarter and 9% next year. At less than 15 times trailing earnings, these shares offer a 22% discount to their industry average and an 8% discount to their five-year norm. LabCorp of America is a Focus List Buy and a Long-Term Buy.

LOW-VOLATILITY STOCKS WORTH A LOOK
Each of the nine A-rated stocks below earns a Quadrix Value and Overall score of 70 or higher, trades at a price/earnings ratio below the industry average or its own five-year norm, and is expected to grow per-share profits at an annualized rate of at least 7% over the next five years. All nine qualify as either Low or Below Average risk based on our Risk Rating. Stocks on our recommended lists are in bold.
---- Price/Earnings Ratio ----
Profit
Growth
Est., Next
5 Years
(Annual.)
(%)
--- Discount To ---
Quadrix Scores
Company (Price; Ticker)
Div.
($)
Yield
(%)
Trailing
Industry
(%)
History
(%)
Value
Overall
Industry
Risk
Rating
AmerisourceBergen
($78; ABC)
1.46
1.9
14
(50)
(23)
11
94
84
Health providers
Low
Amgen ($144; AMGN)
4.00
2.8
13
(24)
(48)
7
85
92
Biotechnology
Low
Biogen ($294; BIIB)
0.00
0.0
15
(44)
(39)
9
79
90
Biotechnology
Below
Avg.
Carnival ($51; CCL)
1.40
2.7
16
(25)
(36)
16
84
90
Leisure
Low
CVS Health ($77; CVS)
1.70
2.2
14
(29)
(26)
11
96
84
Food retailing
Low
Disney ($99; DIS)
1.56
1.6
17
(8)
(10)
9
77
78
Media
Below
Avg.
HCA Holdings ($71; HCA)
0.00
0.0
11
(12)
(41)
11
96
96
Health providers
Below
Avg.
LabCorp of America
($126; LH)
0.00
0.0
15
(7)
(18)
10
84
70
Health providers
Low
Lear ($130; LEA)
1.20
0.9
10
(12)
(30)
12
98
99
Auto components
Below
Avg.
Notes: Quadrix scores are percentile ranks, with 100 the best. Risk level is determined by our Relative Risk scores. Low and Below Average are the two least-risky rankings out of five levels of risk.

 


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