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Stock Screen: Low-Risk Stocks for Worthwhile Total Return - November 23, 2011
Conservative investors can readily find low-risk stocks. Of course, there is a tradeoff between risk and return, and low-risk securities often produce commensurately low returns. With this in mind, we screened the Value Line database for stocks that combine below-average risk with worthwhile total return (price appreciation and dividends) potential over the long haul. First, we limited the field to equities with Above Average Safety ranks, which are stocks that, in our opinion, have less-than-normal total risk. Next, we required price appreciation potential to 2014-2016 of at least 70%. Then, we specified that the remaining equities must have a current dividend yield of at least 2.8%. From that list, we excluded any issue with projected three- to five-year average annual dividend growth of less than 5.0%.
In order to tie the growth and income criteria together, we also required an average annual total return over the next three to five years of 17%, which is favorable given the returns currently available. Finally, we eliminated all holdings with subpar prospects for market performance over the next six to 12 months (those ranked Below Average for Timeliness). This step was taken to screen out stocks that are most at risk of underperformance in the near term, in spite of their otherwise attractive investment attributes.
Given our stringent criteria, it is not surprising that our screen only produced six names. Although small, this is an elite group of stocks that appears suitable for patient investors who seek worthwhile total returns, but are also averse to excess risk. This list should be particularly useful in today’s market, given the volatility that has been prevalent as investors deal with the uncertain prospects for economic growth.
Microsoft (MSFT - Free Microsoft Stock Report) is the largest independent maker of software in the world. The Redmond, Washington based company divides its operations into five segments: Windows & Windows Live Division (27% of fiscal 2011 revenue), Server and Tools Division (25%), Online Services Division (3.5%), Microsoft Business Division (32%), and Entertainment and Devices Division (12.5%). Its product suite includes operating systems for personal computers, servers, phones, and other intelligent devices; server applications for distributed computing environments; productivity applications; business solution applications; desktop and server management tools; software development tools; video games; and online advertising.
The company has faced concerns about its future in a post-PC age, but we remain sanguine on its outlook. The launch of Windows 8 (expected sometime in 2012) should provide the top line with a shot in the arm, and we like the company’s initiatives in the tablet and smartphone spaces.
Microsoft has been actively supporting shareholder value through both stock repurchases and dividend payouts. In September of 2008, after the completion of its previous buy-back authorization, Microsoft announced a new $40 billion repurchase program to run through September 2013. As of June 30, 2011, about $9.5 billion remained under this endorsement, after the company bought back 447 million shares for $11.5 billion during fiscal 2011, 380 million shares for $10.8 billion in fiscal 2010, and 318 million shares for $8.2 billion during fiscal 2009. We fully expect the inking of a new authorization once the current remaining allotment has been exhausted.
The software giant recently increased its quarterly dividend, as well. The payout hike of 25%, to $0.20, maintains a good track record of dividend growth, and brings the yield at the current quotation to just under 3.5%. We think a fresh product pipeline and talented engineers should support strong top line advances over the next several years. Moreover, MSFT stock carries a below-market Beta of .85 and solid scores for Price Stability and Financial Strength, making it a good play as a hedge against market volatility as well.
Eaton (ETN) is a diversified global power management company and technology leader serving the vehicle, construction, commercial, and aerospace markets. It breaks its operations into five business segments: Electrical (further divided between domestic operations, which were 27% of 2010 revenue, and international operations, 20% of 2010 revenue), Hydraulics (16%), Aerospace (11%), Truck (15%), and Automotive (11%). The company’s products include electrical components/systems for power distribution, quality, and control; hydraulics components for industrial and mobile equipment; aerospace fuel hydraulic and pneumatic systems for commercial and military use; as well as truck and automotive drivetrain & powertrain systems for fuel economy and safety.
We like Eaton’s use of cash, as it appears to have found an effective balance between returning value to shareholders and making strategic acquisitions to bolster future growth. Indeed, while maintaining a solid payout, ETN has recently been on a buying binge. It spent nearly $300 million on acquisitions over the first nine months of 2011, compared to about $180 million during the same period last year, and purchased two additional companies in August alone (IE Power, Inc. and E. Begerow GmbH & Co. KG). Though the company has been successful in amalgamating product and technology additions into its operations so far, an overactive acquisitions strategy can risk creating integration headaches. As such, it is also an active participant in joint ventures, such as the 51% Eaton-owned Intelligent Switchgear venture with Caterpillar (CAT - Free Caterpillar Stock Report).
The company increased the quarterly dividend payout by 17% at the beginning of this year, to $0.34 compared to $0.29 in last year’s December period. At the current quotation, this represents a yield of just under 3.5%, well ahead of the Value Line median.
The recent increase in bookings ought to permit favorable near-term earnings gains. Long term, shares of Eaton stock have room for ample price appreciation, and, thus, good potential for a healthy total return. Moreover, with high marks for both Financial Strength and Price Stability, the issue offers a good balance between risk and return.
Subscribers can see the full results of our screen, complete with Timeliness and Safety ranks, by clicking here. As always, we strongly urge investors to consult the individual analyses in Ratings & Reports before committing to any of the issues that appear in this screen. All data are from The Value Line Investment Survey dated November 25, 2011.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.