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Stock Screen: Beta and the (Nearly) Bear Market - October 7, 2011
In the wake of the recent gyrations in the stock market, many investors are likely seeking ways to limit the volatility of their own portfolios. Those looking to retain there exposure to equities, while gaining some additional downside protection, may want to take a closer look at the betas of their holdings. On each Value Line report, a stock’s beta can be found on the top left part of the page, just below our Timeliness, Safety, and Technical ranks. In layman’s terms, beta is a measure of the degree to which a stock’s price changes in relation to movements in the broader market. Stock with betas above 1.00 would be expected to make a diversified portfolio more volatile than the broader market, while those with betas below 1.00 should reduce the volatility of a diversified portfolio.
Intuitively, low beta portfolios would seem to have been a good place to be during the recent slump in the markets. To put such an assumption to the test, we used Value Line’s stock screen tool to create two hypothetical portfolios using beta as the key variable. We then compared their respective performances over the past three months. To qualify for inclusion in our low beta portfolio, a stock had to have a beta of 0.65 or below, while the high beta portfolio was comprised of equities with betas of 1.75 or above. This resulted in two groups of roughly 90 stocks each.
As might be expected, the low beta portfolio won in a rout. Granted, the median return for this group was still in negative territory (-2%), but this compares quite favorably to the S&P 500, which fell more than 10% over this same stretch. The low beta portfolio consisted primarily of shares of established companies operating in relatively noncyclical industries. Among the top performers over the past three months, electric utilities were well represented, with Progress Energy (PGN), Consolidated Edison (ED), and Duke Energy (DUK) among those that were able to resist the downward pull of the broader market. Two of the big name food processors General Mills (GIS) and Hershey Co. (HSY) put in strong showings, as well. Investors also rallied around the shares of another, perhaps less known industry participant, Diamond Foods (DMND), after the purveyor of snacks and nuts reported better-than-expected results for its July quarter.
The recent performance of the high beta portfolio, on the other hand, was rather gruesome. The median total return for this group over the past three months was roughly –35%. A sizable number of industries were represented in this group, with those whose prospects are most closely tied to the macroeconomic economic environment, such as auto parts and hotel/gaming, being found in abundance.
Still, investors, particularly those with a healthy appetite for risk, shouldn’t be too quick to dismiss a high beta portfolio. Data from 2009, a year that began with falling stock prices and deep concerns about the direction of the economy, provide a glimpse of the potential upside from such a strategy. Using our stock screener again, we compared the performance of the two portfolios for that year, which ultimately marked the onset of the recent bull market. The numbers reveal that the high beta stocks produced a median total return of nearly 100%. By comparison, the gains generated by the low beta group were fairly pedestrian (median: 12%).
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.