Stocks that are intentionally low risk, low return

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psteinx
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Stocks that are intentionally low risk, low return

Post by psteinx »

It's often implicitly or explicitly assumed that most stocks have broadly similar risk/return profiles. And if a stock has a nearly bond-like operating return (steady earnings, with ability to raise prices in-line with inflation), then there often seems to be a management imperative to lever up such that the levered corporation has risk/return profile not too different from the market.

A broad example of this is REITs. In theory, a collection of, say, apartment buildings, spread across the country, WITHOUT leverage (maybe even with some significant cash reserves), should be a pretty low risk/low volatility business, at an operating level. Sure, vacancies and non-payments would rise some in a broad recession, but probably not a ton. But IIUC, typical practice is for REITs to borrow a lot, and thus they can get pretty hammered in a recession. IIRC, REITs did about as bad or somewhat worse than the stock market as a whole in '08-09.

Farmland and timberland ownership (unlevered) could be low risk. Utilities could be low risk. A stable basket of consumer goods/brands (Colgate, WD-40, Dove soap) could be low risk, etc.

But are there any/many examples where management consciously and explicitly accepts this, trading off lower-than-market returns for lower to much-lower than market risk?

I'm not looking for statistical constructs here. I know about low vol/low beta funds. I'm thinking more about a small collection of stocks that could, if 1929-1933 happens again, survive a substantial, say 30%, economic contraction, higher taxes, and credit drying up, because their assets/businesses franchises are so strong and they take on so little financial and/or operating leverage. Such a group could also, hopefully, survive a ~1922-3 Weimar-like (or modern Venezuela) hyperinflation, because they'd (hopefully) have pricing power.
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hand
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Re: Stocks that are intentionally low risk, low return

Post by hand »

Traditionally these are known as "widows and orphans" stocks with high amount of safety and substantial dividends.

This group has historically included utilities, but in some (many?) cases today's utilities are markedly different than those of yesteryear because of use of leverage and greater focus on short term vs long term stewardship. Of course owning a smaller basket of theoretically "safe" stocks caries uncompensated single-stock risk, so even if you could find the stocks you describe, you'd need to ask if you are truly achieving your desired goal.

Alternately, you could simply own fewer stocks.
secondopinion
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Joined: Wed Dec 02, 2020 12:18 pm

Re: Stocks that are intentionally low risk, low return

Post by secondopinion »

psteinx wrote: Tue Oct 19, 2021 11:33 am It's often implicitly or explicitly assumed that most stocks have broadly similar risk/return profiles. And if a stock has a nearly bond-like operating return (steady earnings, with ability to raise prices in-line with inflation), then there often seems to be a management imperative to lever up such that the levered corporation has risk/return profile not too different from the market.

A broad example of this is REITs. In theory, a collection of, say, apartment buildings, spread across the country, WITHOUT leverage (maybe even with some significant cash reserves), should be a pretty low risk/low volatility business, at an operating level. Sure, vacancies and non-payments would rise some in a broad recession, but probably not a ton. But IIUC, typical practice is for REITs to borrow a lot, and thus they can get pretty hammered in a recession. IIRC, REITs did about as bad or somewhat worse than the stock market as a whole in '08-09.

Farmland and timberland ownership (unlevered) could be low risk. Utilities could be low risk. A stable basket of consumer goods/brands (Colgate, WD-40, Dove soap) could be low risk, etc.

But are there any/many examples where management consciously and explicitly accepts this, trading off lower-than-market returns for lower to much-lower than market risk?

I'm not looking for statistical constructs here. I know about low vol/low beta funds. I'm thinking more about a small collection of stocks that could, if 1929-1933 happens again, survive a substantial, say 30%, economic contraction, higher taxes, and credit drying up, because their assets/businesses franchises are so strong and they take on so little financial and/or operating leverage. Such a group could also, hopefully, survive a ~1922-3 Weimar-like (or modern Venezuela) hyperinflation, because they'd (hopefully) have pricing power.
Let us compare safety with quality.

Safety refers to the general reduced level of volatility. In theory, this should result in reduced returns. Diversification cannot dislodge this fact; holding a diverse basket would work to obtain it.

Quality refers to the high likelihood of good returns. In theory, this should not result in reduced returns. Instead, it places a negative skew on those returns. Why? Because quality is priced into the stock. The question of quality drives the stock price down quicker than the volatility would suggest. The skew of quality, however, can be diversified out of a portfolio; a basket of stocks removes this skew.

So, back to these "low risk" companies. Their lack of leverage does increase their quality; it would take a lot to dislodge their returns. However, the stock is likely expensive because of it. On the other hand, if the potential returns are indeed limited because of their conservative nature, then we should expect the stock price to be lowered. However, even these companies can be hammered in their stock price regardless. They will suffer less, but they will suffer anyway.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
cfa-ish
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Re: Stocks that are intentionally low risk, low return

Post by cfa-ish »

Berkshire Hathaway has pretty steady returns in terms of rolling average of book value growth (to smooth out the volatility of the returns of its massive stock portfolio). Insurance is not particularly steady, but its other "groves" as Buffett describes them, are: railroads and utilities. It also has unusually low leverage. Note that the high leverage in utilities and railroads is confined to the subsidiaries and the parent is not on the hook for them. As you know utilities/railroads can safely carry more debt than your average stock.
In the recent past, its P/B is pretty well approximated by a constant (1.4).
All in all, it is part of my low-risk, low-return portfolio. It will however, go up and down with the index in the short term. But if any company in S&P can survive, it will. Maybe along with Google and the defensive stocks you mentioned (consumer staples, utilities, perhaps energy and materials).
JBTX
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Re: Stocks that are intentionally low risk, low return

Post by JBTX »

cfa-ish wrote: Tue Oct 19, 2021 1:29 pm Berkshire Hathaway has pretty steady returns in terms of rolling average of book value growth (to smooth out the volatility of the returns of its massive stock portfolio). Insurance is not particularly steady, but its other "groves" as Buffett describes them, are: railroads and utilities. It also has unusually low leverage. Note that the high leverage in utilities and railroads is confined to the subsidiaries and the parent is not on the hook for them. As you know utilities/railroads can safely carry more debt than your average stock.
In the recent past, its P/B is pretty well approximated by a constant (1.4).
All in all, it is part of my low-risk, low-return portfolio. It will however, go up and down with the index in the short term. But if any company in S&P can survive, it will. Maybe along with Google and the defensive stocks you mentioned (consumer staples, utilities, perhaps energy and materials).
https://www-thestreet-com.cdn.ampprojec ... n-aapl.png

40% of BH is Apple.
secondopinion
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Re: Stocks that are intentionally low risk, low return

Post by secondopinion »

JBTX wrote: Tue Oct 19, 2021 1:35 pm
cfa-ish wrote: Tue Oct 19, 2021 1:29 pm Berkshire Hathaway has pretty steady returns in terms of rolling average of book value growth (to smooth out the volatility of the returns of its massive stock portfolio). Insurance is not particularly steady, but its other "groves" as Buffett describes them, are: railroads and utilities. It also has unusually low leverage. Note that the high leverage in utilities and railroads is confined to the subsidiaries and the parent is not on the hook for them. As you know utilities/railroads can safely carry more debt than your average stock.
In the recent past, its P/B is pretty well approximated by a constant (1.4).
All in all, it is part of my low-risk, low-return portfolio. It will however, go up and down with the index in the short term. But if any company in S&P can survive, it will. Maybe along with Google and the defensive stocks you mentioned (consumer staples, utilities, perhaps energy and materials).
https://www-thestreet-com.cdn.ampprojec ... n-aapl.png

40% of BH is Apple.
Their stock portfolio or their entire company? They are a company and their company operations are diverse.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
drk
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Joined: Mon Jul 24, 2017 10:33 pm

Re: Stocks that are intentionally low risk, low return

Post by drk »

There's a guy on "fintwit" who's obsessed with these kinds of wide-moat/cockroach companies that just chug along and compound through good times and bad (e.g., WD-40, Philip Morris/Altria). His name is Lawrence Hamtil. Reading through his feed may provide some inspiration.

That said, I'm skeptical that the corporation as an institution would survive a Weimar/Venezuela event.
A useful razor: anyone asking about speculative strategies on Bogleheads.org has no business using them.
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