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The Beta Dogs Of The Dow

|Includes: McDonald's Corporation (MCD)

Today, I published my second article about McDonald's. In this post, I would like to introduce a useful methodology that helped me to identify this no-brainer investment opportunity for long-term investors, particular those investing in a tax-advantaged account like a Roth IRA.

I call it the Beta Dogs of the Dow. The idea is simple. Instead of emphasizing the valuations of all the Dow components (P/E, dividend yield, market cap, recent price action, etc.), we should first and foremost look at the price movement of the Dow stocks in relation to the overall market (using the S&P 500 as a proxy). This metric is known as a stock's beta.

If the correlation between the stock and the market over a 5-year period is low, particularly for high-volume large cap stocks as are found in the Dow, chances are more than good that this correlation will revert to its long-term average mean, which by definition is 1. The reverse is also true. High beta stocks should, in the long run, also revert to 1.

Wharton professor Marshall Blume first noticed "that beta coefficients tend to regress towards the grand mean of all betas over time" in an article titled "Betas and Their Regression Tendencies" published by The Journal of Finance in 1975. You may know this technique as Adjusted Beta, which is the name used by some statistical software packages.

But as the idea somewhat flies in the face of the Capital Asset Pricing Model (CAPM) so widely used by analysts today, this phenomenon is often overlooked. Perhaps it is because the strategy only works, as the professor says, "over time" and by this he means the looooooooong run.

However, given that the best investors have just this timeframe, we can use the Beta Dogs of the Dow as a list to unearth ideas to generate superior investment returns. Follow me here or at LowBetaPortfolio.com to make sure you know as soon as the rankings of this list change.

You may ask, "LBP, why are you so darn bullish on McDonald's (NYSE:MCD) these days?"

To which I would reply, "That's easy! With a 5-year beta of 0.33, MCD is currently the biggest Beta Dog of the Dow, so sign me up!"

If you ever happen to ask me that question, now you know what's up.

Disclosure: The author is long MCD, VZ.