How can investors find less risky stocks?
— -- Q5: How can investors find stocks that won't be as risky as the market?
A: Investors love volatility when stocks are going up. But when they're going down? Not so much.
At the same time, savvy investors know that avoiding all risk is practically a sentence to poor returns. The looming risk of greater inflation in the future, while it hasn't happened yet, is a reminder to investors that playing it too safe can be a big mistake, too.
So what are investors to do? How can investors find stocks that tend to be less risky than the stock market?
Pinpointing less-risky stocks has been the subject of research by T. Rowe Price's Sudhir Nanda. Through his research, he found that investors can boost their chances of owning less risky stocks if they go for those with:
•High return-on-equity. Stocks that generate large profits relative to value of the money invested in the business, measured by ROE, tend to be less risky.
•Solid dividend yields. Dividends have accounted for 42% of the total return of the market since 1926. Furthermore, stocks that pay dividends tend to outperform those that don't by 1.2% a year based on an analysis by Nanda of large and mid-sized companies.
•Generate high cash flow. The companies that are able to bring in healthy streams of cash are less risky.
•Don't have large levels of debt. Debt may boost returns and profits during the good times, but can also drag down a company's performance in the bad times.
•Are consumer staples or health care companies. Companies that make necessities, like toothpaste and other consumables, plus health care companies tend to be less subject to the vagaries of the market in the short term.
These are just some of the traits that less-risky stocks have had in common during the past. And while some may seem apparent, it's a good reminder. Many of these prudent traits of companies are ignored by investors during bull markets. And that can be a dangerous thing as investors have the tendency to load up on risky stocks when times are good, and then get beat up by the volatility when the stock market turns hostile.
Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Follow Matt on Twitter at: twitter.com/mattkrantz
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