There was a point in time when a Dow Jones Industrial Average advance of 100 points was considered a “big” day. Even though such moves are still quite large statistically speaking, 100 points doesn’t seem to elicit as much notice anymore. However, as an investor, watching such gyrations can be nerve racking, to say the least.
The truth is, markets are volatile. They always have been and always will be. While there are profits to be made in volatility, there are also great risks. For more conservative investors, or those just looking for a temporary respite, there is no way to completely avoid volatility—but there are ways to try to minimize its impact on a portfolio.
Diversification is one way. The simple concept of not putting all of one’s eggs in a single basket is a great tool, but it isn’t the only tool. Individual stock selection is another important part of the equation.
Value Line provides a number of tools for subscribers to use when examining individual stocks, a few of them can help in the selection of less volatile (boring?) equities. From a “big picture” perspective, subscribers can look at the proprietary Value Line Safety ranks. This rank appears in the Ranks boxat the top left of all Value Line equity reports and is a measure of the potential risk associated with an individual common stock.
The Safety rank is computed by averaging two other proprietary indexes, the Price Stability Index and the Financial Strength rating. Both of these measures are found at the bottom right of a Value Line report in the Ratings box. Safety ranks range from 1 (Highest) to 5 (Lowest). Conservative investors would be well served if they limited their purchases to equities ranked 1 (Highest) or 2 (Above Average) for Safety.
To see a concrete example, examine the Coca-Cola (KO – Free Value Line Research Report for Coca-Cola) stock report. The Ranks box shows the Safety rank of 1; the Ratings box shows a Financial Strength rating of A++ and a Price Stability score of 100—each of which is the highest scores we accord.
The Financial Strength rating is a relative measure of the financial strength of the companies reviewed by Value Line. The relative ratings range from A++ (Highest) down to C (Lowest), in nine steps. They are assigned by Value Line’s team of analysts and editors based on such factors as debt load, company size, and earnings history, among others. Stock Price Stability is a relative ranking of the standard deviation of weekly percent changes in the price of a stock over the past five years. The ranks go from 100 for the most stable to 5 for the least stable. In plain English, companies with more stable share prices get a better score here.
Also included in the Ratings box are Price Growth Persistence and Earnings Predictability. These, too, can help subscribers find companies that won’t keep them up at night. Both of these ratings range from 100 (Highest) to 5 (Lowest). Price Growth Persistence is a measure of the historic tendency of a stock to show persistent price growth compared to the average stock. Note that this isn’t a measure of the size of the change, as it only tracks the regularity with which a stock’s price has gone up.
Earnings Predictability is a measure of the reliability of an earnings forecast. Predictability is based upon the stability of year-to-year comparisons, with recent years being weighted more heavily than earlier ones. The Earnings Predictability is derived from the standard deviation of percentage changes in quarterly earnings over an eight-year period. Special adjustments are made for comparisons around zero and from plus to minus.
Coca-Cola scores well on Earnings Predictability, but not as well on Price Growth Persistence. One slightly subpar score doesn’t mean that Coca-Cola should be pushed aside in the search for a better option, it is just a factor to keep in mind. Indeed, since Coca-Cola has so many other strong scores, it is definitely worth continuing to examine the stock—particularly relative to other investment candidates being considered.
Moving back to the Ranks box at the top of each Value Line report, subscribers might also consider looking at beta. Beta is a statistical measure of the historical sensitivity of a stock’s price to overall fluctuations in the broader market. A beta of 1.50 indicates a stock tends to rise (or fall) 50% more than the New York Stock Exchange Composite Index. The ‘‘Beta coefficient’’ is derived from a regression analysis of the relationship between weekly percentage changes in the price of a stock and weekly percentage changes in the broader market over a period of five years. In the case of shorter price histories, a shorter-time period is used, but two years is the minimum. The betas are adjusted for their long-term tendency to converge toward 1.00.
Clearly, investors seeking to sleep well at night should avoid betas of 1.50, or more, and focus their attention on stocks with betas below 1.00. Although such shares shouldn’t be expected to fully participate in a market advance, neither should they be expected to fully participate in a market decline. Coca-Cola, for its part, has a beta of 0.60—suggesting that its moves will be muted relative to the broader market. General Electric (GE – Free Value Line Research Report for General Electric), for comparison, has a beta of 1.20.
Note, too, that General Electric only receives a 3 for Safety—two notches below that of Coca-Cola. Digging deeper, GE’s Financial Strength is B++ and its Price Stability is 65. Keep in mind that these aren’t weak scores, but they are just lower than those of Coca-Cola. They suggest a stock that is likely to be more volatile. So, if sleeping well at night is important, Coca-Cola is likely a better option than GE.
While there are no silver bullets or crystal balls in investing, Value Line’s reports, and the many proprietary rankings and ratings it contains, can help investors fine-tune their portfolios to better fit their needs and investment profiles. If the market’s gyrations have upset your sleeping habits, putting every stock you own or are considering to the same tests we’ve applied to Coca-Cola and GE would make a lot of sense.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.