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For roller coaster ride fatigued investors, looking for stocks with lower volatility with higher return than the S&P 500 is probably in order.

While history is not future, stocks with superior performance over short, medium and long periods may tend to suggest superior performance in the near future - no certainty there, but not a bad place to look more deeply and ponder the future.

Reviewing all stocks listed in the United States, we found 28 that had a lower three-year volatility and higher three-year total return than the S&P 500, and which also had a higher total return than the S&P 500 for one-year, five-years and 10-years, and a better total return in the crash year 2008, and have at least a $100 million market-cap. They are listed in the table below with some valuation multiples, rolling returns, calendar year returns and trailing yield.

Click images to enlarge

We call these "NorthWest Quadrant" stocks, because in a scatter diagram (shown below) of volatility and return, they all fall in the upper left quadrant of the chart. The chart plots volatility on the horizontal axis and return on the vertical axis. The vertical axis intersects the horizontal axis at the volatility and return of the S&P 500 index (called "benchmark").

The point called "portfolio" is a hypothetical equal weighted portfolio of the 28 stocks, rebalanced monthly.

Assuming a hypothetical portfolio of those 28 stocks equally weighted and rebalanced monthly, the standard deviation, mean return, and Sharpe Ratio (basically return for risk taken versus volatility experienced) would have been superior to the S&P 500 (called "benchmark" in the table above) for three years, five years and 10-years.

Note that the volatility of the portfolio is lower than the lowest volatility of any of the individual stocks, but the return is the average of the returns. That is a basic principle of diversification. The volatility of the individual stocks are out of phase with each other and tend to partially cancel the effect on the portfolio, whereas you achieve the position weighted average.

That same hypothetical portfolio would have underperformed the S&P 500 in 13 of the past 40 quarters, and outperformed the S&P 500 in 27 of the quarters. In most of the cases the portfolio underperformance was for two quarters back-to-back.

The histogram above plots the difference between the hypothetical portfolio return and the S&P 500 return each quarter.

Just as markets tend to have down years frequently, even if they generate long-term positive returns, a portfolio of winners, still seldom if ever escapes periods of underpeformance.

The stocks in the NorthWest Quadrant list are generally defensive in nature. They may not do as well going forward as they did looking backward, but we suggest they are a worthy list to examine further in terms of future expectations.

While they would probably be left behind in total return in a strong up market, they may produce positive returns with comparatively low volatility, but only time will tell. We think a defensive component to portfolio equity allocations still makes sense in the current macro situation.

In a prior article, we identified NorthWest Quadrant equity ETFs.


Disclosure: QVM has long positions in HNZ, MCD, and NLY in some accounts, and does not have positions in any other mentioned security as of the creation date of this article (January 5, 2011).

Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions. This article is presented subject to our full disclaimer found on the QVM site available here.