7 Stocks That Let You Sleep Tight

published 25 May 2012

Despite double-digit returns since the stock market bottomed last fall, investors remain skeptical. Many have stayed on the sidelines, unconvinced that the market offers either a fair shake or fundamental value. Others are put off by recent, massive market swings in a matter of hours or even minutes, with seemingly little rhyme or reason behind the volatility. Since October, investors have pulled nearly $80 billion out of U.S. stock funds, while bond fund coffers continue to swell.

Other investors have become doubters precisely because the market is up so far so fast. They fear that a pullback is on the way. “We’ve received calls from clients questioning the recent upswing’s sustainability,” says Cory Haith, an investment adviser at Syverson Strege & Co., in Des Moines. “There is certainly concern over volatility.” (See Kiplinger's Stock Market Update.)

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

https://cdn.mos.cms.futurecdn.net/hwgJ7osrMtUWhk5koeVme7-200-80.png

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

That surprising conclusion, gleaned from recent research in academia and finance, turns an investing truism on its head: Taking on greater risk does not yield greater returns. In fact, it’s the other way around. A paper coauthored by Brendan Bradley, director of managed volatility strategies at Boston’s Acadian Asset Management, and business professors at Harvard and New York universities, calls the winning record of low-volatility stocks “the greatest anomaly in finance.”

Going back to 1968, says Bradley, a basket of the least-volatile stocks delivered annualized returns of 11.4% through 2011, compared with 9.5% for Standard & Poor’s 500-stock index. Looking at monthly figures, the maximum peak-to-trough loss for the S&P 500 was 51%. But the maximum decline for low-volatility stocks was 32%. Because of the way the math works, large losses cost investors more than big gains can make up.

The drawback to a low-volatility strategy is that it will lag in bull markets. Investors should commit to their low-volatility holdings at least through a complete bull- and bear-market cycle. Volatility in relation to the overall market is easy to gauge by looking at a stock’s beta -- which you can find on investing sites such as Google Finance. The market, typically represented by the S&P 500, has a beta of 1; a beta of 0.50 indicates volatility that’s half that of the market. (Beta is not a perfect indicator of volatility; for example, gold-mining stocks usually have low betas but are highly volatile.)

There are four -- just four -- companies with a perfect, AAA credit rating from Standard & Poor’s. Automatic Data Processing (symbol ADP) is one of them. (Two others, ExxonMobil and Johnson & Johnson, are featured below; the fourth is Microsoft.) That fact alone should help ADP investors rest easy. ADP’s dividend payments should give them some sweet dreams, too. The company has raised its payout every year for 36 years, and the annual dividend has grown from $1.16 per share in 2008 to $1.58 this year. ADP has also repurchased more than 100 million shares over the past five years.

The company is a bet on an improving economy and a rosier employment picture. Based in Roseland, N.J., ADP is the world’s largest provider of outsourced payroll services, with more than 570,000 clients. The payroll giant also provides comprehensive personnel services to smaller firms, and it supplies accounting, leasing, inventory and parts-ordering services for auto dealers. A recent acquisition gives ADP entree into the huge medical-billing business. ADP’s clients stick around for longer than ten years, on average, says Morningstar.

The Atlanta-based company is investing billions of dollars in overseas markets (which account for 70% of sales), especially in countries such as China, Russia and Brazil. Emerging markets represent a bright future. It’s estimated that someone in China consumes 34 servings of Coca-Cola products per year, according to analysts at Morningstar. That’s up from just eight in 1998, but it’s a far cry from the 394 servings per capita that Americans quaff every year.

Coke battled higher commodity prices last year but recently announced a plan to shave annual costs by $550 million to $650 million by the end of 2015. Analyst Caroline Levy, at Credit Agricole Securities, expects Coke to reduce manufacturing costs in the U.S. by closing older plants, upgrading others and building at least one new state-of-the-art facility in North America. Over the long term, she thinks Coke can generate double-digit annual earnings growth. The stock, at 18 times estimated earnings, isn’t cheap. But the bulls say it deserves to trade between 18 and 19 times earnings.

ExxonMobil (XOM) may have ceded its claim as the world’s most valuable company to Apple (AAPL), but the energy giant has something Apple doesn’t: a corporate history spanning more than a century and a reputation for safety befitting a stock with a market value of $400 billion. “Within energy, Exxon is the most defensive stock,” says Raymond James analyst Pavel Molchanov. “If someone thought oil prices were going to $50 a barrel, Exxon would be the out-performer.”

Oil prices aren’t going to $50 -- Molchanov sees the price of Brent crude averaging $90 per barrel next year -- but Exxon faces other challenges. The Irving, Tex., company has cut back its refining business, for example, as demand for oil in developed countries shrinks. Another hurdle is a huge stake in North American natural gas production at a time when a glut has pushed gas prices to ten-year lows. And opportunities for energy production growth overall are limited -- especially considering how big a project it takes to move the needle at Exxon.

But the company’s functional and geographical diversity, along with deep pockets and extensive expertise, give it unparalleled muscle to compete globally, be it in Canada or Qatar, West Texas or West Africa. Analysts at International Strategy & Investment call the company’s balance sheet a “fortress,” strengthened with $13 billion in cash. Exxon has a long policy of returning cash to investors via share buybacks and dividends, and analysts speculate that Exxon is poised to boost the dividend significantly.

There’s no denying that restaurants suffer when times are tight: Diners stay home and the cost of food rises. But if anyone can stand the heat in the kitchen, it’s McDonald’s (MCD). The Oak Brook, Ill., company benefits as frugal consumers trade down, of course. But McDonald’s continues to gain market share in the developed world, even though restaurant demand is muted, and is also benefiting from the proliferation of golden arches in emerging markets. All told, there are more than 33,500 McDonald’s locations in 119 countries.

Nobody does fast food better. The world’s largest chain in terms of sales, McDonald’s enjoys big economies of scale and wields significant bargaining clout with suppliers. According to Morningstar, McDonald’s restaurants, on average, generate about $2.7 million per year in sales, easily trumping the fast-food industry average of just over $1 million per location. New menu items, including specialty coffees and fruit smoothies, have been hits. CEO Jim Skinner is stepping down, but his successor, current president and chief operating officer Don Thompson, has been the heir apparent for a while, and the transition should be seamless, says Morningstar.

If you’re looking for Marlboro country, you’ll find it in Asia. And if your portfolio is free of no-smoking restrictions, you’ll find an attractive stock in Philip Morris International (PM). Headquartered in New York, PMI was spun off from Altria (MO) in 2008 to separate the tobacco giant’s domestic holdings -- and the litigation and regulatory risks that cloud it -- from the company’s international businesses. Wells Fargo Securities analyst Bonnie Herzog says Philip Morris “should be a core holding in an investor’s portfolio for the next three to five years.”

And yet P&G has not been immune to the consumer belt-tightening caused by economic malaise in the U.S. and in Europe. So it has responded with some belt-tightening of its own. The Cincinnati company recently announced a $10 billion, five-year cost-savings program aimed at plumping profit margins. Savings targets include $3 billion in corporate overhead and $1 billion in marketing costs. Additional savings could come from more-efficient product design and formulating -- more-concentrated laundry detergent, for instance -- which would cut the cost of raw materials and packaging, as well as transportation and warehouse expenses. If the plan works, P&G will have more flexibility to finance strategic investments and to expand into new product categories and new markets -- a big focus is on the emerging middle class in developing markets.

Topics

Anne Kates Smith brings Wall Street to Main Street, with decades of experience covering investments and personal finance for real people trying to navigate fast-changing markets, preserve financial security or plan for the future. She oversees the magazine's investing coverage, authors Kiplinger’s biannual stock-market outlooks and writes the "Your Mind and Your Money" column, a take on behavioral finance and how investors can get out of their own way. Smith began her journalism career as a writer and columnist for USA Today. Prior to joining Kiplinger, she was a senior editor at U.S. News & World Report and a contributing columnist for TheStreet. Smith is a graduate of St. John's College in Annapolis, Md., the third-oldest college in America.