Week 228 - Barron’s 500 Stocks with 5-16 Yrs of Below-Market Volatility and Above-Market Returns

Situation: You don’t want to lose sleep worrying about your stock portfolio, but you also don’t want to depend entirely on index funds for retirement planning. Most readers of this blog have decided to supplement their retirement income with dividend checks that grow 2-5 times faster than inflation. The stockpicker’s goal is to get risk-adjusted returns that meet or beat S&P 500 Index returns. That takes a lot of time and requires understanding how markets work, meaning a steep learning curve extending over 10 or more years. And, it is almost impossible to find stocks that will perform for you at the high level over the long term (as this week’s blog makes clear). To get that result you would need to become a short-term trader of stocks that are not widely followed by analysts (Google “Peter Lynch” to see what I mean). If you’re not willing to become that kind of trader, then a better choice is to invest in the lowest-cost S&P 500 Index fund, the Vanguard 500 Index Fund (VFINX), or its bond-hedged version, the Vanguard Balanced Index Fund (VBINX). Or, accept that fact that few of your long-term stock picks are going to have total returns that out-perform the S&P 500 Index on a risk-adjusted basis over 2-3 market cycles.

Mission: Find stocks that have better risk-adjusted returns than the S&P 500 Index over 2-3 market cycles. Start by looking at the largest companies in the US and Canada using the Barron’s 500 List to gain information about key fundamentals. Specifically, we want to find those that have had below-market volatility over the past 5 and 16 years and returns that have beat the S&P 500 Index over the past 5 and 16 years. Eliminate any stocks that have S&P bond ratings lower than BBB+ or S&P stock ratings lower than B+/M.

Execution: We have been able to identify only 6 stocks that satisfy our criteria (see Table). If you have been reading our blog regularly, you’ll know that we call such stocks unicorns. Four of these 6 unicorn stocks pay an above-market dividend, and the other one (Nike) increases its dividend more by than 20% a year. Our list has turned up “bond substitutes” of high quality but all bond substitutes are in great demand. Why? Because the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 has eliminated the ability of banks to trade bonds for their own account. In other words, the principal market for bonds has dried up. It is going to be a long time before bonds again become a place where you can park money in anticipation of interest payments that more than compensate for inflation. 

And now, a word about the method we use to find unicorns in the Barron’s 500 List. To find companies with Below-market volatility over the past 5 yrs, we use 5-yr Beta, and at 16 yrs we use the predicted loss that would be incurred if the stock’s price dropped 2 Standard Deviations below trendline, per the BMW Method. To find companies with above-market returns at 5-yrs, and since the S&P 500 Index peaked on 9/1/00, we use the Buyupside total return stock calculator. To assess the past 16 years of price appreciation, we use the BMW Method. All comparisons are to either the S&P 500 Index or the lowest-cost stock mutual fund that mimics that index (VFINX). 

Bottom Line: We’re looking for “unicorn” stocks and found 6 (see Table). The method we use will probably never turn up more than 10 stocks, given that outperformance is almost always accompanied by greater volatility. The problem for you, the reader, is that we’ve used historical data. In other words, there’s no way of knowing whether these 6 stocks will continue to outperform while exhibiting below-market volatility.

Risk Rating: 4 

Full Disclosure: I dollar-average into NKE, UNP and NEE.

Note: Metrics highlighted in red denote underperformance vs. our key benchmark (VBINX). Metrics are current for the Sunday of publication.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com