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Robert Abbott
Robert Abbott
Articles (799)  | Author's Website |

High Returns From Low Risk: How to Identify the Right Stocks

Here’s how the authors identify low-risk stocks that should outperform in the long run

Invest in low-risk stocks that have both income and momentum. In a nutshell, that’s the advice provided so far in the 2016 book, “High Returns from Low Risk: A Remarkable Stock Market Paradox.”

In chapter 10, authors Pim Van Vliet and Jan de Koning explained how to identify stocks that meet these three criteria. They laid out, in previous chapters, the reasoning why portfolios of such stocks would easily outperform low-risk stocks without income and momentum, and dramatically beat high-risk stocks.

To make the search easier, they proposed a substitution. That is, they recommended “beta” rather than volatility as the proxy for risk. According to the authors, beta is much the same, but simpler to use and more stable over time.

Beta represents the general market, and despite the market’s ups and downs, it is always exactly 1. Any stock that has a beta of less than 1 is considered low risk, while anything above 1 is considered high risk. If a stock goes up 15% when the market goes up 10%, it’s beta will be 1.5.

That’s easier to work with than volatility, which is a relative number; as the authors pointed out, volatility of 25% could be a high number or a low number. Why? Because it is tied to the volatility of other stocks or securities in the market. Investopedia defines volatility as “a statistical measure of the dispersion of returns for a given security or market index. In most cases, the higher the volatility, the riskier the security. Volatility is often measured as either the standard deviation or variance between returns from that same security or market index.”

Van Vliet and de Koning noted they used a period of 52 weeks as a proxy for momentum because it is more stable than shorter periods. Still, they cautioned it is a fluctuating measure and could change at any time; the 52-week period is only a snapshot in time.

Let’s look at a couple of examples, beginning with Apple (NASDAQ:AAPL) (all values as of June 2016):

  • Beta: 0.9
  • Dividend yield: 1.7%
  • 52-week price change: 27%

Based on this data, we see that Apple would be considered low risk (beta of less than 1), has modest income (1.7%) and positive momentum of 27%. Is that good? Yes, it meets all three criteria. Beyond that, it depends on what’s available from other stocks.

Here are the data for Microsoft (NASDAQ:MSFT):

  • Beta: 1.0
  • Dividend yield: 2.7%
  • 52-week price change: 10%

Here we have a stock that would not make the low-risk cut because it is not below 1, even though it has income and positive momentum.

Would you add Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) to your low-risk portfolio?

  • Beta: 0.8
  • Dividend yield: 0.0%
  • 52-week price change: -1%

No. While it does make the cut as a low-risk stock, it did not have any income at that time and it had negative momentum.

Suppose you were interested in buying stock in a car company in June 2016, and you looked at data for Germany’s Daimler (XTER:DAI) and Japan’s Mitsubishi UFJ (NYSE:MUFG):

You would buy neither of the companies. Both have high-risk betas and both have negative momentum. Remember, you are always looking for beta of less than 1, positive income and dividend yield and positive momentum.

The authors’ list included two stocks from Japan, NTT (NTT) and KDDI (KDDIF) that match all three criteria:

In the following chapter, the authors will explain how to use stock screeners to find large-cap stocks that fit all three of their criteria.

Conclusion

To return to the main premise of this book, it is that low-risk stocks will outperform high-risk stocks over time. However, just being a low-risk security is not enough to ensure above-average returns. These stocks also must generate income by way of dividends or buybacks and must have positive momentum as measured by the price trend.

In chapter 10 of “High Returns from Low Risk: A Remarkable Stock Market Paradox”, Van Vliet and de Koning elaborated on the characteristics of low-risk, income and momentum.

Low risk was defined by beta, dividend yield was the proxy for income and momentum was defined as a price increase over the preceding 52 weeks.

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About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the "unseen revolution."

Visit Robert Abbott's Website


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