Lower risk, higher return

7/14/2008


Few people think about risk management when stocks are on the rise. But in today’s market, the idea of managing risk sure sounds comforting.

Investors who buy volatile stocks expect to be compensated in the form of higher-than-average returns. Low-risk stocks are generally expected to provide subpar returns, and such stocks often have little appeal during bullish markets. But this year’s market action, with sharp declines in January, February, and June, illustrates the importance of low-volatility stocks with defensive characteristics.

Our Relative Risk rating considers several volatility-related metrics and classifies stocks in five categories: Low risk, Below Average risk, Average risk, Above Average risk, and High risk. There are no high-risk stocks on our Monitored List. These risk scores are presented every month in our Monitored List supplement, which is included with today’s issue.

As the chart below shows, stocks on our Monitored List with Low or Below Average risk ratings have averaged a price decline of 9.4% for the year, better than the S&P 500 Index’s 13.3% decline and similar declines for stocks with Average and Above Average risk scores.

Investors can further improve their odds by sticking with stocks that earn Quadrix® Overall scores of 80 or more. High Quadrix scorers in the lower-risk group averaged a modest price decline of 3.8%. In the following paragraphs we discuss two stocks with modest volatility and robust return potential.

The slowing economy has — so far — been good news for Accenture ($41; NYSE: ACN), as a growing number of companies seek its outsourcing and consulting expertise. As the business environment becomes more challenging, clients rely on Accenture to cut costs and improve performance. Accenture’s surprising resilience (shares are up 14% so far this year) may not last should conditions significantly deteriorate, but the company expects to post strong results over the next year.

Accenture earns a Below Average risk rating. The company generates much of its business through long-term contracts, which provide a steadier stream of revenue and profits than those of most tech companies. Earnings estimates have risen over the last month, thanks to a strong May-quarter performance and upbeat guidance. Consensus estimates project 34% growth in per-share earnings for fiscal 2008 ending August and 10% growth in fiscal 2009. Accenture has topped estimates in seven of the last eight quarters and seems well-positioned to beat estimates over the next 12 months. Accenture is a Focus List Buy and a Long-Term Buy.


Aflac ($63; NYSE: AFL) is on track to post 23% per-share-earnings growth this year. Consensus estimates project another 14% increase in 2009. CEO Dan Amos promised to produce at least 15% annual profit growth in his first 20 years at the company, and Aflac has managed annualized per-share growth of 18% since Amos took over in 1990. The dividend has grown even faster, rising at an annualized rate of nearly 19% since 1990, with the most recent increase a 15% hike in March.

With no subprime-mortgage holdings in its investment portfolio, Aflac has sidestepped some of the problems facing other insurers. Additionally, the company is poised to continue growing over the next 18 months.

In Japan, the source of 71% of 2007 revenue, Aflac controls the country’s most widely recognized insurance brand. Demand for Aflac’s products is increasing as Japan’s national health program shifts more costs to individuals. New products, increasingly effective sales training, and new distribution outlets through banks and the national postal service should help boost sales of new policies. Aflac, which earns a Low risk rating, is a Long-Term Buy.


Relative Risk revealed
The Forecasts’ Relative Risk score measures five statistics related to stock-return volatility over the last five years:

  • Bull-market performance.
  • Bear-market performance.
  • Standard deviation (how widely stock returns are dispersed around the average).
  • Beta (historical volatility relative to the S&P 500 Index).
  • The stock’s worst three-month performance, a statistic useful for assessing downside risk.

 


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