5 Safe Stocks to Swap Into

Risk, you might have heard, is directly related to stock returns. That is, you’re not supposed to be able to achieve greater stock returns without taking on more risk. Be skeptical.

The theory comes from a set of elegant mathematics first published in the Journal of Finance in 1952, then mostly ignored for a decade, then transformed in the early 1960s through more lovely math into a stock prediction machine called the Capital Asset Pricing Model. The formulas gave rise to the index mutual fund industry in the 1970s and earned two key contributors Nobel Prizes in economics in 1990.

One of the upshots of the math is that if you know something called “beta” for a stock, you can calculate the stock’s expected return. So what’s this remarkable beta? In theory it’s a measure of risk. In practice, risk is a tricky thing to measure, so beta is often based on a stock’s past trading volatility relative to other stocks. A stock that moved frantically in the past has a high beta today, which means it’s supposed to be risky, which means it’s supposed to earn high returns in the future. But no one wants the extra risk, so we’re all better off forgetting about stock picking and buying index mutual funds.

Indexing is probably the best thing to come out of the math. Those Vanguard funds are blessedly cheap, and since over long time periods mediocre stocks are better than no stocks, the funds are a good deal for investors who aren’t keen on stock-picking, which is most of them.

For stock pickers, the formulas don’t quite deliver as promised. Past volatility isn’t terribly accurate for predicting future returns. Other clues, when added to volatility, result in more accurate predictions. Among these are a company’s size, or what you’d pay to own all of its shares today, and its price/book value, which compares the purchase price to what accountants say the assets are worth. All else held equal, small companies and cheap companies tend to produce better stock returns. Mathematicians say this is because these clues are actually alternative measures of risk in disguise. That is, small companies are riskier than big ones, and what is cheapness if not a sign of flaws, and thus, risk? So the theorists worked these new clues into the pricing model to turn that volatility-based beta into a “three-factor” beta, but more good clues like recent share price momentum turned up soon after. They added those in, too.

I’ve lost track whether we’re up to five or six factors, but the process has become a bit circular. Every time researchers find a clue that reliably predicts good stock returns, other researchers redefine that clue as part of a new measure of risk. Do that for long enough and risk really will be inseparable from return, because the two will be different labels for the same things.

That’s a long lead-in to the subject of which stocks investors should swap into now if they feel the market has gotten expensive, and they suddenly care more about safety than returns. Risk, I’m convinced, isn’t something to be throttled back on at the expense of returns. The best way to reduce risk is to be greedy for return. That doesn’t mean placing wild bets. Sometimes it means holding cash. With regard to stocks, it means continually searching for modest valuations, big, reliable dividends, strong balance sheets and other good clues.

Below are listed five companies whose shares seem attractively priced — safe, you might say.