LONDON -- After several months of weakness, the London stock market is showing some recent strength.
As I write, the blue-chip FTSE 100 index of elite U.K.-listed companies has risen by roughly 160 points since June 28, which is an uplift of about 3% in seven trading days. This rise followed an unusually successful euro-summit offering real concessions to struggling Italy, Spain, and Ireland.
Central banks act
Nevertheless, growth in the U.K. and eurozone has been weak of late, so central banks once again rode to the rescue.
On Thursday, the European Central Bank cut its main interest rate to 0.75% from 1% -- the lowest level since the ECB was established in 1998. Clearly, the ECB is hoping lower borrowing costs will lead to increased spending by individuals and greater investment by companies.
Here in Blighty, the Bank of England has less room to maneuver, having already cut its base rate to a mere 0.5% -- the lowest level in the Bank's 318-year history. Thus, on Thursday the Bank revealed "QE3" -- its third round of quantitative easing, often dubbed "money printing."
On top of the 325 billion pounds pumped into the economy by QE1 and QE2, the Bank has added another 50 billion pounds in the form of QE3. Banks benefit greatly from QE, as it improves their liquidity and lowers their funding costs. Alas, QE harms pensioners by lowering annuity rates, and it may also push up inflation by increasing the money supply.
Another relief rally?
When the Bank launched QE1 and QE2, share prices rallied strongly for months afterward. Hence, if QE3 gets a similar reception, then the London market may continue to build on its recent upswing.
But which shares are likely to do best in steadily rising markets? The answer could be shares with high "betas." Beta is a measure of an asset's volatility, relative to its wider market. For instance, a beta of less than one indicates that a share is less volatile than the wider market. Similarly, a beta greater than one means a share tends to move up and down with greater volatility than its peers.
Therefore, shares with high betas tend to rise more quickly during market upswings but dive more steeply when Mr. Market is feeling gloomy.
Twelve high-beta Footsie shares
To find out more about blue-chip betas, I screened the FTSE 100 to find high-beta candidates. I found:
53 shares with a beta of one or more.
24 shares with a beta of at least 1.5.
12 shares with a beta of 1.8 and above.
Hence, I'm going to take a look at the fundamentals of these 12 highest-beta candidates to see which stick out as potential bargains. Here are these "dynamic dozen" stocks, sorted from lowest to highest beta:
Market value (billions of pounds)
Aviva (ISE: AV.L)
Eurasian Natural Resources (ISE: ENRC.L)
Lloyds Banking Group
Royal Bank of Scotland
Barclays (ISE: BARC.L)
Kazakhmys (ISE: KAZ.L)
Vedanta Resources (ISE: VED.L)
Unsurprisingly, this table of high-beta shares lists companies with high recovery potential if and when the U.K. and global economies improve. It contains seven mining firms, three banks, one insurer, and one engineer.
For today's exercise, I will not simply single out those shares with the highest betas. After all, if the market goes into reverse, then these stocks should suffer most. Hence, I will choose five stocks which have both high betas and value characteristics to protect investors' potential downside.
Five big names to watch
I tend to avoid companies with double-digit price-to-earnings ratios, which eliminates four firms. Also, I will reject RBS because of its lack of a dividend, plus Rio Tinto and Xstrata, whose dividend yields (both 3.3%) are below the market average.
This leaves the following five high-beta shares with value features:
1. Aviva (beta of 1.8)
On a forward P/E of 5.4 and a prospective dividend yield approaching 10%, Aviva certainly looks cheap as chips to me. Also, it has just announced a major restructuring aimed at improving its returns on capital. This is surely a share for dividend devotees and deep-value diggers.
2. ENRC (beta of 2)
This is a racy stock and, therefore, not one for widows and orphans to pile up. I say this because ENRC operates in the "Wild East" of mining (in former Soviet states) and has had more than its fair share of corporate-governance run-ins. With a P/E of six and dividend yield of 3.6%, it trades at "danger money" levels, but this rating has room for future improvement.
3. Barclays (beta of 2.4)
Barclays, its management, and its share price have been under the cosh since last week, when it admitted to manipulating LIBOR. If you think this news has harmed the bank's business model as badly as it has hit its reputation, then you should steer well clear of Barclays.
Then again, if you think a P/E of 5.8 and dividend yield of 4.2% sound appealing, then you may be able to look beyond recent events and play the long game by buying into a battered Barclays.
4. Kazakhmys (beta of 2.4)
Being in the same sector and ex-Soviet region as ENRC, Kazakhmys comes with similar warnings. Even so, it trades on a P/E of 5.4 and offers a modest dividend of 2.5%, making it the lowest-yielding of my five high-beta firms. In fact, I would have left out Kazakhmys on dividend grounds, had it not been for its high dividend cover (a whopping 7.4 times), which offers high upside for increased cash payouts.
5. Vedanta (beta of 2.6)
Lastly, another miner -- this time Indian giant Vedanta, a leading producer of copper, zinc, aluminum, and iron ore with interests in the energy market.
Vedanta was once my largest-ever shareholding, so I can vouch for its volatility. In the time I owned it, Vedanta's share price went from 10 pounds to 27 pounds, before later collapsing to less than 4 pounds and then soaring back up to 30 pounds! Right now, this Indian jewel trades on an ultra-low P/E of 4.7 and offers a prospective dividend yield of 3.9%.
Of course, what remains to be seen is whether the recent market rally has legs to stand on or will stumble and collapse. For the answer to this particular riddle, please consult your crystal ball!
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