(By Rich Bieglmeier) Since caveman investors discovered fire and the wheel, stock market participants have operated under the assumption that more risk equals more reward. It's a basic tenant in the halls of the finest academic institutions and research departments across Wall Street.
Guess what? It's all wrong according to a new study entitled Low Risk Stocks Outperform within All Observable Markets of the World. The authors, Nardin L. Baker and Robert A. Haugen say "The fact that low risk stocks have higher expected returns is a remarkable anomaly in the field of finance. It is remarkable because it is persistent – existing now and as far back in time as we can see."
The study was conducted by breaking stocks into deciles, quintiles, and halves based on the volatility of total return for each company, in each country, during the previous 24 months. The winning portfolio consists of the 10% of stocks with the lowest standard deviations. At the start of each month, the screen is repeated, and the groupings rebalanced.
Going back to 1990, Baker and Haugan report "past volatility is a good predictor of future volatility. In the Universe and in each individual country low-risk stocks outperform." And Facebook (FB) sings, how ya' like me now.
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Source: Low Risk Stocks Outperform within All Observable Markets of the World
Since 1990, low volatility stocks have outperformed their high risk cousins on a three-year rolling basis nearly constantly, with only two extremely brief bouts of subpar returns.
The study points out that high volatility stocks "tend to be noteworthy, often by virtue of receiving media attention. Because the flow of new information about these stocks is relatively intense, stocks of this type tend to exhibit higher than average volatility."
The research shows "volatile stocks are, in fact, covered more intensely by the media" with the number of stories on the Dow Jones Wire ranging from 7,220 in 1990 year to 17,778 in 2011.
The evidence suggests the more attention a company receives in the press, the more likely an analyst will cover it. In fact, the largest 1000 U.S. stocks are the most widely held, are "more volatile," and "attract more analysts' coverage."
The moral of the story is to forget everything you always believed about risk and reward, ignore companies highlighted on CNBC or the financial papers on a regular basis, and if XYZ Corporation has 20 analysts opining, disregard their advice and look elsewhere because each is leading you down a path of high risk and underperformance.
Lest you think we'll leave you hanging, iStock screened all companies that are $3 or more and trade an average of at least $500,000 a day. From there, we ranked the nearly 3,000 qualifying companies based on their volatility of total return for the past 24 months. Then, we created 10 buckets based on standard deviation, from lowest to highest.
With roughly 300 equities in each group, unless you are a multi-billion dollar hedge fund, nobody can buy all 300. The average investor needs to be a bit more discerning. Once again, iStock did the work for you by screening the lowest volatility stocks for some of our favorite technical analysis buy signals.
Thirteen of the 300 popped out, they include:
ALLETE, Inc. (ALE)
American Tower Corporation (AMT)
Ecolab Inc. (ECL)
Jack Henry & Associates Inc. (JKHY)
LTC Properties Inc. (LTC)
PG&E Corp. (PCG)
ProAssurance Corporation (PRA)
The Clorox Company (CLX)
Dollar Tree, Inc. (DLTR)
Kimberly-Clark Corporation (KMB)
Southern Company (SO)
Piedmont Natural Gas Co. Inc. (PNY)
Allied World Assurance Company Holdings, AG (AWH)