Published December 4th, 2018 by Josh Arnold
In the world of investing, volatility matters. Investors are reminded of this every time there is a downturn in the broader market and individual stocks that are more volatile than others experience enormous swings in price.
Volatility is a proxy for risk; more volatility generally means a riskier portfolio. The volatility of a security or portfolio against a benchmark is called Beta.
In short, Beta is measured via a formula that calculates the price risk of a security or portfolio against a benchmark, which is typically the broader market as measured by the S&P 500.
Beta is helpful in understanding the overall price risk level for investors during market downturns in particular. The lower the Beta value, the less volatility the stock or portfolio should exhibit against the benchmark. This is beneficial for investors for obvious reasons, particularly those that are close to or already in retirement, as drawdowns should be relatively limited against the benchmark.
Importantly, low or high Beta simply measures the size of the moves a security makes; it does not mean necessarily that the price of the security stays nearly constant. Indeed, securities can be low Beta and still be caught in long-term downtrends, so this is simply one more tool investors can use when building a portfolio.
Here’s how to read stock betas:
A beta of 1.0 means the stock moves equally with the S&P 500 A beta of 2.0 means the stock moves twice as much as the S&P 500 A beta of 0.0 means the stocks moves don’t correlate with the S&P 500 A beta of -1.0 means the stock moves precisely opposite the S&P 500Interestingly, low beta stocks have historically outperformed the market… But more on that later. You can download a spreadsheet of the 100 lowest beta stocks (as measured by 5 year beta) below:
Table of Contents
The Evidence for Low Beta Outperformance How To Calculate Beta Beta & The Capital Asset Pricing Model (CAPM) Analysis On 5 Of The Best Low Beta High Dividend Stocks Final ThoughtsThe Evidence for Low Beta Outperformance
The conventional wisdom would suggest that lower Beta stocks should underperform the broader markets during uptrends and outperform during downtrends, offering investors lower prospective returns in exchange for lower risk.
However, history would suggest that simply isn’t the case. Indeed, this paper from Harvard Business School suggests that not only do low Beta stocks not underperform the broader market over time – including all market conditions – they actually outperform.
A long-term study wherein the stocks with in the lowest 30% of Beta scores in the US were pitted against stocks with the highest 30% of Beta scores suggested that low Beta stocks outperform by several percentage points annually.
Over time, this sort of outperformance can mean the difference between a comfortable retirement and having to continue working. While low Beta stocks aren’t a panacea, the case for their outperformance over time – and with lower risk – is quite compelling.
How To Calculate Beta
The formula to calculate a security’s Beta is fairly straightforward. The result, expressed as a number, shows the security’s tendency to move with the benchmark.
In other words, a Beta value of 1.0 means that the security in question should move virtually in lockstep with the benchmark. A Beta of 2.0 means moves should be twice as large in magnitude while a negative Beta means that returns in the security and benchmark are negatively correlated; these securities tend to move in the opposite direction from the benchmark. This sort of security would be helpful to mitigate broad market weakness in one’s portfolio as negatively correlated returns would suggest the security in question would rise while the market falls.
Here’s a look at the formula:
The numerator is the covariance of the asset in question with the market, while the denominator is the variance of the market. These complicated-sounding variables aren’t actually that difficult to compute – especially in Excel.
Additionally, Beta can also be calculated as the correlation coefficient of the security in question and the market, multiplied by the security’s standard deviation divided by the market’s standard deviation.
Finally, there’s a greatly simplified way to calculate Beta by manipulating the capital asset pricing model formula (more on Beta and the capital asset pricing model later in this article).
Here’s an example of the data you’ll need to calculate Beta:
Risk-free rate (typically Treasuries at least two years out) Your asset’s rate of return over some period (typically one year to five years) Your benchmark’s rate of return over the same period as the assetTo show how to use these variables to do the calculation of Beta, we’ll assume a risk-free rate of 2%, our stock’s rate of return of 7% and the benchmark’s rate of return of 8%.
You start by subtracting the risk-free rate of return from both the security in question and the benchmark. In this case, our asset’s rate of return net of the risk-free rate would be 5% (7% – 2%). The same calculation for the benchmark would yield 6% (8% – 2%).
These two numbers – 5% and 6%, respectively – are the numerator and denominator for the Beta formula. Five divided by six yields a value of 0.83, and that is the Beta for this hypothetical security. On average, we’d expect an asset with this Beta value to be 83% as volatile as the benchmark. Thinking about it another way, this asset should be about 17% less volatile than the benchmark while still having its expected returns correlated in the same direction.
Beta & The Capital Asset Pricing Model (CAPM)
The Capital Asset Pricing Model, or CAPM, is a common investing formula that utilizes the Beta calculation to account for the time value of money as well as the risk-adjusted returns expected for a particular asset.
Beta is an essential component of the CAPM because without it, riskier securities would appear more favorable to prospective investors as their risk wouldn’t be accounted for in the calculation.
The CAPM formula is as follows:
The variables are defined as:
ERi = Expected return of investment Rf = Risk-free rate βi = Beta of the investment ERm = Expected return of marketThe risk-free rate is the same as in the Beta formula, while the Beta that you’ve already calculated is simply placed into the CAPM formula. The expected return of the market (or benchmark) is placed into the parentheses with the market risk premium, which is also from the Beta formula. This is the expected benchmark’s return minus the risk-free rate.
To continue our example, here is how the CAPM actually works:
ER = 2% + 0.83(8% – 2%)
In this case, our security has an expected return of 6.98% against an expected benchmark return of 8%. That may be okay depending upon the investor’s goals as the security in question should experience less volatility than the market thanks to its Beta of less than 1. While the CAPM certainly isn’t perfect, it is relatively easy to calculate and gives investors a means of comparison between two investment alternatives.
Now, we’ll take a look at five stocks that not only offer investors low Beta scores, but attractive prospective returns as well.
Analysis On 5 Of The Best Low Beta High Dividend Stocks
First up is Omega Healthcare Investors (OHI). Omega is a healthcare REIT that generates the vast majority of its revenue from skilled nursing facilities. The trust has a history of compounded FFO-per-share growth in the mid-single digits and given long-term tailwinds from an aging population in the US, we believe it will continue to do so. The stock offers investors a dividend yield of 7.4% and a 5-year Beta score of just 0.13.
Click here to see our Sure Analysis Research Report on Omega Healthcare Investors.
Altria Group (MO) is up next and also offers a very high yield and low Beta. Altria sells traditional cigarettes and other tobacco products, along with some relatively newer entries like heat-not-burn products. The company gets the majority of its revenue from its dominant cigarette brands but has diversified to ensure future growth, which we see as mid-single digits or higher. Although tobacco usage volume is declining in the US, Altria’s diversification and pricing increases are more than making up for lower volumes. Altria sports a 6.0% dividend yield and a 5-year Beta of 0.40.
Click here to see our Sure Analysis Research Report on Altria.
AT&T (T) is a telecommunications giant offering customers digital entertainment, television, internet and wireless phone service primarily in the US. The company’s recent acquisitions of DirecTV and Time Warner have left the balance sheet with nearly $200 billion of debt, but AT&T’s steady earnings growth is more than capable of servicing such an enormous amount. We like AT&T’s dividend as well as its newfound growth prospects thanks to Time Warner, which diversifies AT&T away from traditional cable set top box revenue and provides the company with a world-class content library. We think AT&T will grow earnings in the mid-single digits annually moving forward because of these tailwinds. The stock offers a 6.7% dividend yield and has a 5-year Beta of 0.42.
Click here to see our Sure Analysis Research Report on AT&T.
Kraft Heinz (KHC) is a consumer staples giant that sells processed food and beverage products globally. The company’s portfolio includes cheese products, condiments, sauces and dairy products, among others. The stock has been in a significant downturn in recent months and that has driven the dividend yield up to 4.9% while also making the valuation more attractive. Like the other stocks in this list, Kraft Heinz offers investors a high yield and reasonable valuation. However, we see this stock’s earnings growth potential as lower than the others listed here as volume and margin headwinds should keep earnings-per-share growth in the low single digits annually. Kraft Heinz’ 5-year Beta score is 0.59.
Click here to see our Sure Analysis Research Report on Kraft Heinz.
Finally, General Mills (GIS) is a packaged food giant that offers consumers snack and breakfast foods across the globe. The company’s share price has languished in recent years over growth concerns given its leverage to the cereal market, which has been in long-term decline for years. However, we think General Mills can grow earnings-per-share in the low single digits and we also see the current valuation as favorable. General Mills hasn’t cut its dividend for 18 years and offers investors a generous 4.6% yield. The stock’s 5-year Beta score is 0.60, so it is comparable to Kraft Heinz from a volatility perspective.
Click here to see our Sure Analysis Research Report on General Mills.
Final Thoughts
Investors must take risk into account when selecting from prospective investments. After all, if two securities are otherwise similar in terms of expected returns but one offers a much lower Beta, the investor would do well to select the low Beta security as it would offer better risk-adjusted returns.
Using Beta can help investors determine which securities will produce more volatility than the broader market and which ones may help diversify a portfolio, such as the ones listed here.
The five stocks we’ve looked at not only offer low Beta scores, but very high yields and reasonable valuations as well. Sifting through the immense number of stocks available for purchase to investors using criteria like these can help investors find the best stocks to suit their portfolio’s needs.