The economy is only just starting to chug along again. The situation in Europe is relatively unchanged, China is slowing down and banks are still de-leveraging. Yet stock markets are hitting all-time highs. With these mixed market messages, many investors and market commentators are confused about whether the market is overstretched or just warming up.
Wherever we go from here, it is always handy to have stocks in your portfolio that offer some protection from the trend in the general market.
How to defend your portfolio
This is where beta comes in. Beta is an indicator of the systemic risk of a stock in comparison to the market as a whole. For example, a beta of 1 would indicate that the company’s share price moves in line with the market: when the market moves down 1%, the stock price tends to move down 1% with it.
A beta of more than 1, for example 1.5, would indicate that the stock moves more than the market, in this case 50% more (when the market moves 1% the stock tends to move 1.5%). Any stock with a beta of less than 1 is in theory less volatile than the market.
Now, I must mention here that the beta figure is an average of past data. That means that the stock’s future movement in relation to the market is only theoretical. Even with this caveat, beta is a good indicator of how volatile stocks can be.
As an example, here is a chart comparing the price action of General Mills, Inc. (NYSE:GIS), Cliffs Natural Resources Inc (NYSE:CLF), and the S&P 500.
General Mills’ beta figure is around 0.17, depending somewhat on who calculates the figure. Cliffs has a beta of around 2.4, indicating that the stock has moved, on average, 2.4% for every 1% that the market moved.
Cliffs Natural Resources Inc (NYSE:CLF)’s share price has been all over the place during the last few years as volatile commodity prices, rising costs and falling profits have dented investors’ confidence; this is the reason behind the company’s high beta.
In comparison, General Mills, Inc. (NYSE:GIS)’s operations have been relatively stable, and profits and earnings have grown steadily, drawing investors to the stock. This steady uptrend and lack of volatility is the reason for the company’s low beta.
The Vanguard Consumer Staples ETF has a low beta of 0.6 due to its defensive nature:
During 2008, 2009 and 2011 the ETF did not fall nearly as much as the wider market due to its defensive nature, resulting in the ETF’s low beta.
These examples highlight the benefits of selecting stocks with a low beta.
So where to invest?
A low beta figure indicates that a stock could be a safe haven in a falling market. However, in my opinion buying a stock just because it has a low beta can be unwise, as beta is only one indicator.
Buying stocks that are undervalued and have a low beta figure, in my opinion, is the best way of defending a portfolio against market volatility. Here are three low beta stocks undervalued against their peers that could offer a safe haven in this uncertain market.
Contender number one
Abbott Laboratories (NYSE:ABT) has shown a very low correlation to market movements during the past five years, indicating that it is a good choice for a defensive portfolio.
Contender number two
The Kroger Co. (NYSE:KR) has a P/E of 12.5 and a forward P/E of 11.4; that’s lower than its peers in the grocery stores sector, which have an average P/E of 17.6. The company has a P/B ratio of 4.3 against the sector average of 10.6. Kroger appears to be undervalued when compared to the rest of the sector, and the company’s defensive nature means that is has a beta of around 0.4.
The Kroger Co. (NYSE:KR) has very little correlation to the market in general as its products and services are always in demand.
Contender number three
The Chubb Corporation (NYSE:CB) has a P/E of 14.2 and a forward P/E of 12.8, lower than that of its peers in the property and casualty insurance sector, which trade on an average P/E of 16.2. However, the company has a P/B ratio of 1.5 against the sector average of 1, making it look slightly overvalued. That said, the company’s defensive nature means that it has a very low correlation to market movements, resulting in a low beta of 0.5.
The Chubb Corporation (NYSE:CB) has risen steadily higher during the past five years with little correlation to market volatility, which gives it a low beta.
Conclusion
It is hard to beat the market, but it is easier to defend a portfolio against sudden market corrections. These three companies all offer a discount in relation to their peers and a low correlation to the rest of the market, both of which will help keep a portfolio steady in rough markets.
The article Three Stocks that Offer Protection from Market Tantrums originally appeared on Fool.com and is written by Rupert Hargreaves.
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