3 Safe Stocks for Your Portfolio

Stocks with minimal operating and price risk for your 2016 holdings

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Mar 21, 2016
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It’s not difficult to see the stock market has gotten off to a bumpy start for 2016. However, the three stock picks discussed below represent fairly safe investment vehicles – even in volatile markets like this one.

Intact Financial Corp.

Intact Financial Corp. (TSX: IFC) is one of the safest stocks in the market right now for a number of reasons. Intact Financial is one of the largest insurance providers in Canada with more than $7 billion in earned premiums and an estimated market share of 17%. Intact Financial has a strong sustainable competitive advantage due to extreme risk aversion in its claimant portfolio, a large-scale advantage and highly specialized and efficient in-house claims expertise. Its multichannel distribution strategy also helps diversify and grow its customer base.

Intact Financial is a top industry performer. Management is highly focused on corporate value creation and targets a return on equity (ROE) spread above the industry average of +5%. During the past 13 years, Intact Financial’s highest ROE was 20.85%. The lowest was 4.42%, and the median was 12.55%. While it has been unable to meet its target objective every year, Intact Financial's current ROE is ranked higher than 65% of the 131 companies in the Global Insurance – Property & Casualty industry. In particular, while the industry median ROE is currently 9.9%, Intact Financial is earning an ROE of 12.3%.

Intact Financial targets net operating income per share growth of 10% per year. Intact Financial’s 2015 reported operating income per share was $7.14. Revenue growth averaged 7.7% per year over the last 10 years and 8.2% over the last five years. EBITDA growth averaged 4.2% and 5.4% per year over the same period respectively. After accounting for depreciation and amortization charges, Intact Financial’s operating income growth clocked-in at 2.2% and 4.8% per year. While below target, the target itself was unrealistically high and should not be viewed as a point of concern.

Intact Financial is financially strong, stable and has increased its dividend each year since its IPO. Its record of strong capital generation and disciplined redeployment speaks to the firm’s ability to effectively utilize its asset-base and further characterizes its conservative and low-risk claim portfolio.

Shares have traded down 5% over the last year. The current dividend is $2.12 per share annually, making the current yield 2.4%. In 2016, analysts predict that Intact Financial will earn $6.50 in diluted earnings per share and $7.16 in 2017, which puts the payout ratio at a modest 40%. We value the company at about 14x EPS. This implies capital appreciation potential of about 13%. Including dividends, we anticipate a return of 15% to 16% on the position.

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Verizon Communications Inc.

Verizon Communications Inc. (VZ, Financial) is one of the world’s largest providers of communications, information and entertainment products and services to consumers, businesses and governmental agencies. The company offers voice, data and video services and solutions on its wireless and wireline networks. Wireless communications products and services include wireless voice and data services and equipment sales, which are provided to consumer, business and government customers across the U.S. Wireline’s voice, data and video communications products and services include broadband video and data, corporate networking solutions, data center and cloud services, security and managed network services and local and long distance voice services.

Verizon’s management has produced plenty of value for shareholders over the last decade. Verizon’s stock has appreciated by 73% from 2006 to 2016. Net margins have consistently beaten its peer group and, at 15.7%, are higher than 80% of the 482 companies in the Global Telecom Services industry (Industry Median: 4.3%). Verizon’s returns have also comfortably beaten its peer group, producing a high ROE of 124.5%, a low ROE of 2.5% and a median ROE of 12.9% over the last 13 years. Verizon's ROE is ranked higher than 98% of firms in the industry (Industry Median: 8.4%).

Being a market leader in a mature industry, it's not easy for Verizon to find new growth opportunities; however, management believes that, with recent acquisitions and fiber-optic transformation growth, the company will continue to generate solid returns for investors. Verizon's growth trajectory includes projections in the range of 1% to 2% per year, increasing net margins by about 15 basis points annually and free cash flow generation in the range of about 8% to 12% of revenues.

The company has increased its dividend each year over the last 10 years, including its 3% dividend hike for 2015, when it raised annual payments from $2.16 per share to $2.23. The dividend yield stands at nearly 4.2%, and the payout ratio is quite reasonable at nearly 50% of earnings for the current fiscal year. We value the company at about 16x EPS. Given the market's EPS expectations moving forward, this implies capital appreciation potential of about 20%. Including dividends, we anticipate a return of about 20% to 25% on the position over a two-year period.

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Coca-Cola Co.

Investors follow various indicators to judge whether a stock is safe. Beta is one of the most popular indicators, which measures a stock's volatility relative to a market benchmark such as the Standard & Poor's 500. And while it provides some insights, judging whether a company is “safe” requires looking for more than just low stock price volatility. For us, we’re less concerned about upside Beta and upside stock price volatility than downside Beta and downside volatility. We’re also more about finding companies with strong, durable, competitive advantages, with solid balance sheets, and with revenues and earnings streams that can withstand recessions.

One company that stands out from the crowd in terms of safety is Coca-Cola Co. (KO, Financial). Coca-Cola is the world’s largest beverage company. It owns or licences and markets more than 500 nonalcoholic beverage brands, mainly sparkling beverages but also a variety of still beverages such as waters, enhanced waters, juices and juice drinks, ready-to-drink teas and coffees and energy and sports drinks. It owns and markets four of the world's top five non-alcoholic sparkling beverage brands: Coca-Cola, Diet Coke, Fanta and Sprite. Its beverage products are sold in more than 200 countries. The company's main competitors include, Nestlé (XSWX:NESN, Financial), DPSG, Groupe Danone, Mondelez International Inc. (MDLZ, Financial), Kraft Foods Group Inc., and the Unilever Group. It also competes against numerous beer companies and regional and local retailers that have developed their own store or private label beverage brands.

So what makes Coca-Cola so safe? For one, it has perhaps the strongest and most durable competitive advantages of any firm in the world. Two, Coca-Cola’s revenues and earnings streams are largely insensitive to recessions. Three, Coca-Cola has a weak 0.6 downside Beta during stock market pullbacks. It also generates a ton of cash and has an easily manageable debt-load. From both an operating and stock price perspective, it doesn’t get much safer than Coca-Cola.

We value Coca-Cola at about 23x EPS. This compares to the current 27x EPS (TTM) and the 22x forward EPS. Given the market’s EPS expectations of $1.97 for 2016, $2.10 for 2017 and $2.23 for 2018, we’re forecasting capital appreciation of about 10% to 15% over the next couple of years. With a dividend yield of almost 3%, we expect to earn a total return of about 12.5% to 17.5%.

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Disclosure: SEENSCO does not currently hold any positions in the stocks mentioned.