By JACK HOUGH
U.S. stocks shed more than 2.5% on Tuesday, as Greece's call for a voter referendum threw a newly inked European debt deal into doubt. This, after October proved the best month for stocks in decades. Head-scratching volatility like that has investors scrambling for "low-beta" shares, which are supposed to offer a smoother ride. But there are two problems with that strategy.
First, the benefits of low-beta stocks are exaggerated. Second, the rush to buy them has left many of these shares too expensive, and thus less safe. Ironically, safety-minded investors might be better off searching for bargains among high-beta shares.
Beta is a measure of how wildly the price of an asset has swung relative to changes in a benchmark. For stocks, beta is often based on five years' worth of trading relative the S&P 500-stock index. A stock with a beta of 1.0 has been precisely as volatile as the index. A beta below 1.0 suggests below-average volatility and a negative one suggests a stock zigs when the broad market zags.
Some investors treat beta as a risk measure, but it's nothing of the sort. It overstates the risk of fast-growing companies that traded frantically several years ago but are steady performers today. And it understates the risk of formerly dependable earners that are stumbling now. It also can't anticipate financial risks that don't yet show up in the form of trading volatility.
Nervous investors have been scooping up low-beta shares like food makers and utilities as a way to weather the market's wild swings. Such companies are typically slow-growers, and as such, they normally carry modest share prices relative to company earnings. But among the large, mid-size and small companies that comprise the S&P Composite 1500 index, the median low-beta stock (0 to 0.7) now carries a price-to-earnings ratio that is slightly higher than the index median. In other words, investors are paying a premium for boredom.
SmartMoney.com has pointed this trend out in recent months (see "3 Simple Food Stocks With Caviar Prices" and "When Safe Havens Aren't Safe"). In a Monday research note, Bank of America Merrill Lynch noted that low-beta stocks are, relative to high-beta ones, the most expensive they've been in decades.
That suggests investors should pay more attention to price than volatility, lest they end up with a smooth ride down. Index investors can do that easily enough with an exchange-traded fund that automatically selects stocks with modest prices relative to factors like earnings, cash flow and dividends. Choices with reasonable management expenses include The Rydex S&P 500 Pure Value ETF (RPV)
For stock pickers, below are listed some examples of low-beta shares that are looking pricey, along with high-beta ones that might be bargains.
|LOW BETA, HIGH P/E|
|99 Cents Only Stores||NDN (NDN)||0.47||19|
|Automatic Data Processing||ADP (ADP)||0.69||19|
|Church & Dwight||CHD (CHD)||0.33||18|
|Costco Wholesale||COST (COST)||0.66||22|
|Diamond Foods||DMND (DMND)||0.23||21|
|Dollar Tree||DLTR (DLTR)||0.36||20|
|Flowers Foods||FLO (FLO)||0.16||19|
|The Hershey Company||HSY (HSY)||0.26||20|
|HIGH BETA, LOW P/E|
|Capital One Financial||COF (COF)||1.70||6|
|Kulicke and Soffa Industries||KLIC (KLIC)||2.66||5|