Investing With Shock Absorbers

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This week, Barron's ran an article on the increasing popularity of low-volatility investing. Mr. Market's bumps and hollows have investors willing to trade away some upside potential in exchange for downside protection.

According to Barron's, no fewer than 12 new ETFs offering low-volatility have hit the market so far in 2011. At least seven of those have opened for business just since September.

I'm generally a fan of the stable, large, dividend-paying companies that fit the profile for these funds, but this article raises two caution flags. First, anytime a trend starts to become too popular, prices can rise too far, too fast. I don't think that's the case yet, but it's time to keep a close watch on valuations. Second, a low-volatility portfolio is likely to be very concentrated in a few sectors. PowerShares S&P 500 Low Volatility Portfolio (ASE: SPLV) , for instance, has more than 60% of its portfolio in just two sectors: utilities and consumer staples. A concentrated portfolio isn't a bad thing, just something investors should be aware of when buying any fund.

Low costs and some instant diversification make ETFs great tools for investors who don't want to spend a lot of time building a stock portfolio. But many Fools might be interested in avoiding the small ETF management fees and a shot at beating the indexes with a do-it-yourself, low-volatility stock mix to smooth out Wall Street's speed bumps and potholes. To come up with promising candidates, I used the Motley Fool CAPS screener to sift through a few thousand stocks to find candidates with:

  • Market capitalization above $10 billion.
  • Beta -- a measure of volatility -- less than 0.67.
  • Dividend yield greater than 2%.
  • P/E ratio less than 18 and positive.
  • Positive earnings growth over the past three years.
  • Four or five star rating (out of five) from our CAPS players.

The screen returned 29 names. I then took six of the most promising to build a fairly well-diversified portfolio.

Company

Beta

(3-year)

Current Dividend Yield

P/E Ratio (TTM)

EPS Growth Rate (last 3 years)

CAPS Rating (out of 5)

Sector

Becton, Dickinson (NYS: BDX) 0.592.5%12.78.19

*****

Health care
Chubb (NYS: CB) 0.642.4%10.47.55

****

Financial
General Mills (NYS: GIS) 0.213.2%14.712.93

*****

Consumer goods
McDonald's (NYS: MCD) 0.343.0%18.09.02

*****

Services
Southern (NYS: SO) 0.24.5%17.52.67

*****

Utilities
Kimberly-Clark (NYS: KMB) 0.344.1%16.41.31

*****

Consumer goods

Source: Motley Fool CAPS Screen.

Most of these stocks trade at a premium to the S&P 500 index's P/E around 13, but the stability these businesses offer arguably deserve a premium to the market. Even in troubled times we can expect:

  • Hospitals to need Becton's supplies.
  • Chubb to collect insurance premiums.
  • Store shelves stocked with General Mills and Kimberly-Clark products.
  • McDonald's to flip burgers and brew coffee.
  • Southern to keep the lights on.

A dose of one of the new ETFs -- or a few stable stocks like the ones above -- might be just the medicine to ease the queasiness of a roller-coaster market.

Low volatility doesn't necessarily mean subpar gains. Since adding a McDonald's outperform CAPScall to my scorecard nearly four years ago, the stock has returned nearly 100%, including dividends.

You can follow the companies mentioned by clicking the links below to add them to My Watchlist.

At the time this article was published Fool contributor Russ Krull owns shares of McDonald's and Southern, but no other company mentioned. Motley Fool newsletter services have recommended buying shares of Kimberly-Clark; Becton, Dickinson; Southern; and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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