I love when a good essay comes my way. Like this one!
“Have you ever looked at your portfolio and noticed most of your best-performing investments are in the lowest-risk names? Companies like Berkshire Hathaway (BRK-B), Microsoft (MSFT), and Apple (AAPL), for example.
Look at the best-performing open positions like Constellation Brands (STZ) – the owner of alcohol brands like Robert Mondavi and Corona – has returned nearly 700%. Tobacco giant Altria (MO) is in second place, followed by fast-food icon McDonald’s (MCD).
Buying big, safe, slow-growing businesses has proven time and time again to provide the highest investment returns.
Yes, we all know “Warren Buffett-style investing” can make you rich. But what’s the actual reason this investment style works?
These stocks have a few standout quantitative traits aside from these qualitative basics that can help you identify them in advance. First, they pay good dividends and have a long history of growing those payouts over time. And second (and this is far less understood by most investors), their share prices aren’t volatile. Their stock prices tend to move around a lot less than the market as a whole. That’s because they have a stable cohort of investors who own the company – investors who are unlikely to sell.
I explained that academics measure this advantage by comparing the daily volatility of a company’s share price with the volatility of the benchmark S&P 500 Index – which is composed of the 500 biggest publicly traded companies in the U.S. This is called “beta.”
Stocks with a volatility equal to the S&P 500’s average are awarded a volatility score of 1. That is, the volatility of these stocks is perfectly correlated with the market as a whole. Stocks that move around more have higher betas. So a company that is 50% more volatile than the S&P 500 would have a beta of 1.5. A company that is two times more volatile than the S&P 500 would have a beta of 2, and so on.
In other words, these high-quality companies are more likely to have dedicated, long-term investors. They’re not trading in and out of stocks. As a result, the share prices of these businesses move around less than that of the average publicly traded company.
I’ve long suspected buying this type of business would lead to outperformance in our readers’ investment returns. But I wasn’t able to prove it until I saw a presentation from Dr. Richard Smith. He explained:
“We put together a group of 40 real-life portfolios – real buy and sell data from real investors. I asked my team to back-test all of their different stop-loss and position-sizing strategies against these real portfolios to see which of our tools made the biggest difference in performance. And, I was amazed to see that there was one tool that improved investment performance more than anything else: volatility-based position sizing. If you only ever pay attention to one thing that I have to say, this is it – use volatility-based position sizing.” ”
Now, what makes the above so amazing, is that every stock I select, on the basis of dividend safety first, followed by historical dividend payout, then thirdly, by 10-years of price action, results in my selecting these low Beta-type stocks in the very first place! One doesn’t need to go all the way into volatility-based position sizing, when one is already rounding out their entire stock portfolio with relatively low Beta, that is, low-volatility stocks in the very first place… which is precisely what I do here. And, it appears these issues are S&P 500 market beaters, on average, as well!
Here’s to your successful investing!
Harold F Crowell