“Investors are overwhelmingly buying stocks they hope will have low volatility, with a steady dividend. They want safety. Whether the stock itself is cheap does not factor into current buying behavior.”
We have an objective research system that ranks US stocks based on company-specific financial data. It does not pay attention to headlines, news reports, or human emotion. It simply evaluates stock candidates from a “bottom-up” perspective.
What is this objective system, with its 60+ valuation characteristics (or “attributes”) calculated every week, telling us about current investing trends and opportunities?
Our system’s best-performing attributes at this time are tied to stocks with the following profile:
- low volatility (low “beta”)
- conservative balance sheets
- attractive dividends
- large market capitalizations
- some basic momentum in earnings and stock price
Stocks in this group include global brands like McDonald’s, PepsiCo, Colgate Palmolive, Procter & Gamble, or defensive stocks like Duke Energy, Southern Company, or Consolidated Edison. These may be admirable companies, but they are certainly not “on sale” in the market, relative to what their business models should produce.
Value-based characteristics—i.e., those attributes indicating whether a stock is cheap or not—are not performing well right now. They haven’t performed well for the past two years, frankly. Some of the worst performing attributes are Price-to-Earnings, Price-to-Cash Flow, and Market Value relative to Book Value and Returns on Equity. Over long periods, these attributes tend to drive above average returns. As our clients know, we seek stocks showing these characteristics.
So, the market is seeking and rewarding “safe stocks”—those with stable business trends, a global footprint, and a good dividend yield for income. It is not rewarding stocks that are cheap.
Why don’t we buy more of the safe stocks, so we can play better “defense”? Two reasons. First, we believe valuation matters over the long term. Most stocks matching this “safe” profile do not possess the valuation attributes we believe will reward investors over longer periods. The safe stocks may work better in the short term, but like hockey legend Wayne Gretzky said, we want to skate to where the puck is going, not where it has been.
Second, we seek to play defense through other investment tools. We strive to build diversified portfolios to balance near-term cash needs with long-term capital appreciation. Fixed income investments tend to serve the need for defense, while stocks tend to serve the need for offense.
Recognizing that fixed income offers little yield today, many current investment strategies are reaching for yield in riskier areas, such as stocks. Hence the interest in low volatility, larger sized companies—the hope and expectation is that they won’t be volatile and can offer better yield.
Our stance is that dividends are important, but stocks by nature are some of the more volatile investments. Instead of depending on dividends alone, we seek total returns from portfolios to manage income needs and capital appreciation.
But this is now getting into portfolio theory. The purpose of this post is simply to describe what our proprietary stock selection system is telling us about investment behavior today. We take comfort that our research, whether or not it is beating the market right now, is behaving rationally and doing as we would expect.