By Serkan Unal
Academic research starting back several decades has confirmed a specific anomaly related to low-volatility stocks that contradicts one of the key elements of the Capital Asset Pricing Model (CAPM). CAPM teaches us that higher expected rates of returns are associated with higher assumed risk. However, low-volatility stocks, which are considered less risky than high-volatility stocks and the market as a whole, have produced higher risk-adjusted returns over the long term than both their high-volatility counterparts and the overall market. Low-volatility stocks have achieved this outperformance in part by reducing drawdowns, benefiting from the compounding effect.
There are a number of indices constructed to provide investors with access to low-volatility investing strategies. We looked closer into the S&P 500 Low Volatility Index and the ETF that tracks it [S&P 500 Low Volatility Portfolio ETF (SPLV)] to identify stocks with the lowest realized volatility over the past 12 months, as measured by the standard deviation (variability of returns) of the stocks' daily price returns over the noted period. Below is the list of five large capitalization stocks with the lowest historical volatility over the past 12 months, as measured by the stocks' weights in the noted Index/ETF. While the studied outperformance of low-volatility strategies generally refers to equity portfolios, individual stocks with low historical volatility could also represent a good starting point in the search for the winning stocks in the long haul.
Johnson & Johnson, Inc. (JNJ), a healthcare and pharmaceutical giant, currently tops the list of the S&P 500 low-volatility stocks. The company has a dividend yield of 3.1%, payout ratio of 45%, and five-year annualized dividend growth of 8.0%. Over the past five years, J&J achieved a total return of 7.3% annually. The stock has rallied 26.0% over the past 12 months and is currently trading at a forward P/E of 15x, above its peer group. Aside from low-volatility of returns, which makes J&J a good defensive play, the company is an avid dividend payer, an S&P Dividend Aristocrat with 46 consecutive years of annual dividend increases. J&J has navigated well through its patent cliff and quality control issues, achieving EPS growth of 1.5%, annualized, over the past five years. With the fiscal cliff effect mostly behind it, the company is expected to achieve a long-term EPS CAGR of 6.5% for the next half-decade, one of the highest rates among its peers. J&J's strong attributes include a diversified product mix, robust new product portfolio, solid balance sheet, attractive dividend, and increasing exposure to emerging markets. In fact, with a forecasted 10%-to-13% CAGR in the 2011-2016 period, emerging market growth will lead the company's top line growth (CAGR of 3% to 6%) in the noted period. J&J is one of the largest positions in hedge funds managed by billionaires Ken Fisher and Donald Yacktman.
H. J. Heinz Company (HNZ), a food products company best known for its namesake ketchup, is also a top large-cap low-volatility stock. It has a dividend yield of 2.9%, payout ratio of 58%, and five-year annualized dividend growth of 6.3%. The stock gained a lot of attention recently as Warren Buffett's Berkshire Hathaway and 3G Capital made an offer to buy the company for $28 billion. The deal would represent a 20% premium to HNZ's stock price on February 13, 2013. The company's shareholders will vote to approve the buyout on April 30, 2013. HNZ stock achieved a total return of 12% over the past five years. This year alone, it is up 36.6%, reflecting Buffett's bid, and trading at 20x forward earnings, above its peers on average. The company has been growing its top line at an annualized 5% rate and its EPS at an annualized 8.4% rate since 2006. HNZ expects to see revenue growth of about 4% and EPS growth of 5% to 8% this year, in constant currency terms. The company's strengths include leading global brands, strong and profitable emerging market growth, robust cash flow generation, and experienced management. The stock represents a good value, despite trading at a price-to-book of 7.6, above its industry's 5.2. Last quarter, HNZ was a holding in value investor Bernard Horn's portfolio.
Pepsico Inc. (PEP), global snacks and beverages giant, also trades at a historically low volatility. It has a dividend yield of 2.7%, payout ratio of 49%, and five-year annualized dividend growth of 7.5%. Recently, the company announced a 5.6% dividend increase, effective as of June 2013. Pepsico has achieved a total return of 4.4% over the past half-decade. Over the past year, its stock has gained nearly 20%. The company has been a leader in the snacks business for a long time and its popular soft drinks have pared well with those of its archrival Coca-Cola Company (KO). Pepsico's strong global brands, emerging market growth, and pricing power are some of its key positive characteristics. The company beat analysts' fourth-quarter EPS expectations, as higher prices and share buybacks boosted the EPS. Pepsico sees a 7% increase in its EPS this year. Recently, rumors emerged about Pepsico's possible acquisition of Mondelez International (MDLZ), fueled by reports of activist investor Nelson Peltz's stakes in both PEP and MDLZ. Pepsico denied the rumors. Instead, it is returning significant sums of cash to investors through buybacks, with a $10 billion share-repurchase plan effective from July 2013, to June 2016. PEP is currently trading at a forward P/E of 17.8x, below its respective industry's multiple of 19.1x. Billionaire Donald Yacktman is a long-term investor in PEP (see Yacktman's portfolio here).
The Clorox Company (CLX), a producer of a wide range of cleaning products, bleaches, water filters and packaged foods, also makes the list of the least volatile large-cap companies. It has a dividend yield of 3.0%, payout ratio of 59%, and five-year annualized dividend growth of 10.8%. An S&P Dividend Aristocrat, the company has raised dividends for 35 consecutive years. Some 90% of the its products are leading brands in their respective categories. With such a strong and wide portfolio of products, CLX has grown its top-line at a 2.5% CAGR over the past five years, with 2012 revenue growth double that long-term average. The company's bottom line has increased at an even more robust 11% CAGR over the past half-decade. This has helped CLX achieve an above-industry Return on Invested Capital (ROIC) of 24%. The company projects a 3% to 5% growth in sales this year and up to 50 basis points in margin expansion. CLX is targeting international markets and the healthcare sector that appears to hold a significant growth potential. The company has also executed a strong buyback program, repurchasing nearly 40% of shares outstanding in the last seven years. Currently, CLX is trading at a forward P/E of 19.5x, slightly above its respective industry. Last quarter, Yacktman held more than $500 million in CLX.
General Mills Inc. (GIS), the maker of branded consumer foods, has a dividend yield of 3.2%, payout ratio of 57%, and five-year annualized dividend growth of 11%. The stock generated a total return of 12.7% annually over the past half-decade. Over the past year, its price has increased 25.6%, resulting in a forward multiple of 17.2x. CNBC's "Mad Money" host Jim Cramer recently discussed multiple expansion at GIS, which he attributed to the willingness of investors to pay more for a reliable and relatively high yield in the current low-yield environment. This is not to say that GIS is exhibiting slow growth. The company has been showing consistently strong profitability. It expanded its EPS at a CAGR of 9% over the past five years, and is expected to grow EPS at a long-term CAGR of 8%, well above the rate of U.S. economic expansion. The main contributor of growth is GIS's international operations, where GIS has made several accretive acquisitions, including Yoki Alimentos and Yoplait Canada. The company has a leading position in its industry, highest margins among its peers, strong management, attractive yield, solid growth forecast, and a forward multiple below that of its industry. In aggregate, these attributes make GIS a solid value proposition.