In and of itself, market volatility isn’t a bad thing, nor is it a risk to long-term investment returns. That being said, volatility has the potential to inspire emotional reactions in even the most seasoned investors, which can lead to poor decision-making.
Every investor is willing to tolerate a different amount of fluctuation in the value of their investments. The importance of knowing your risk tolerance and building a matching portfolio cannot be understated. One investor may see a 10% unrealized loss as a temporary hiccup that will eventually correct, while another may rush to the exits and realize the loss.
With an awareness that many investors seek stock market returns but lack risk tolerance, the finance industry has responded with so-called low-volatility funds. These funds use rules-based investment strategies to weight their investments, with one of the key metrics being “beta.”
Investors don’t need to buy fancy and expensive funds to reduce the volatility of their investments; they simply need to understand beta and apply the approach to their own portfolios.
What is beta?
Beta measures the correlation between a security and the underlying benchmark. The beta of a stock trading on the TSX will show to what degree the security performs like the index.
A stock with a beta of one will track the index, while a stock with a beta of 0.5 will experience only about 50% of the movement of the index, be it up or down. Further, a stock with a beta of negative one will have an inverse relationship with the index, and a stock with a beta of two will experience twice the volatility of the index.
By using beta, investors can find stocks that aren’t wildly impacted by swings in the broad market. In addition, preferring stocks that pay dividends can provide even more stability.
Let’s take a look at an example of a low-beta stock that could present a great investment opportunity.
CCL Industries Inc. (TSX:CCL.B)
CCL is a leading manufacturer and marketer of packaging, labeling, and inventory management products. The company has a global presence and generates roughly 40% of its sales from North America.
On July 3, CCL completed its acquisition of Treofan Americas, further expanding its prodigious business in film labels and packaging and strengthening its geographic footprint.
CCL is a classic example of a low-beta stock because it operates a solid business that isn’t very sensitive to changes in market conditions. Companies need to package and label their products through good times and bad, and CCL is the best equipped to provide that service.
With a beta of around 0.24, CCL doesn’t suffer the commodity-based jitters of the TSX; the stock moves largely in its own direction. Looking at the five-year price chart, the stock’s direction has only been up with a return of approximately 400%, all while earnings have grown at an impressive average rate of over 30% per year.
CCL has a price-to-earnings multiple of roughly 22.5 and a price-to-book ratio of the order of 4.7. The company pays a quarterly dividend of $0.13 for an annualized yield of about 0.8%. CCL has a five-year dividend-growth rate of around 17%, and with a payout ratio below 20%, the dividend has room to grow.
It is important that investors choose stocks that suit their risk tolerance to avoid inopportune selling. Investors who can’t tolerate volatility can achieve exceptional returns all while shielding themselves from uncertainty with high-quality, low-beta investments.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor James Watkins-Strand has no position in any of the stocks mentioned. CCL Industries is a recommendation of Stock Advisor Canada.