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What are we looking for?

Lower-risk U.S. stocks well positioned for 2018.

The screen

Looking back at 2017, investors should be quite happy with their North American portfolio returns, especially for their U.S.-listed stocks. As we near the end of the year, investors can savour the rewards of staying invested and settle in for a well-deserved holiday.

There is worry, however, that this happiness may be short-lived, as many believe these exceptional returns are unlikely to continue for an extended period of time.

This column is the first of a two-part North American strategy built to weather adverse markets. Today, we start with the U.S. component, and next week we will round out the portfolio with Canadian stocks that meet similar criteria. The aim of this portfolio is to hold stocks that provide extremely strong downside protection and withstand any market volatility that may occur – in either marketplace – as we head into 2018.

This strategy ranks stocks based on five-year beta (measures a company's sensitivity relative to historical changes in the benchmark – here, we use the S&P 500; in trending markets, a stock with beta less than one has historically moved less than the index; low values are best) and industry-relative earnings variability (measures how volatile a company's earnings are relative to its industry median; low values are best). Stocks that qualify must have:

  • Five-year beta less than 0.8 (to reduce market sensitivity);
  • Five-year standard deviation of monthly ROE (a measure of risk) less than at least half of peers (today, this value is 2.96 per cent);
  • Industry-relative earnings variability less than one-third of peers (this value today is 7.83 per cent);
  • A market cap at least as great as half of peers (today, this value is $3.28-billion [U.S.]).

More about Morningstar

Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.

What we found

I used Morningstar CPMS to back-test this strategy from January, 2000, to November, 2017. During this process, a maximum of 15 stocks were purchased. Stocks were sold if their five-year beta rose to 1.2 or higher. When sold, the positions were replaced with the highest-ranked stock not already owned in the portfolio.

Over this period, the strategy produced an annualized total return of 11.9 per cent while the S&P 500 total return index advanced 5.7 per cent across the same period.

Downside deviation (measured as the variability of negative returns) was 6.5 per cent compared with a downside deviation of 10.1 per cent for the S&P 500 total return index.

Stocks that qualify for purchase into the strategy today are listed in the accompanying table. As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.

Emily Halverson-Duncan is an account manager for CPMS at Morningstar Research Inc.

A portfolio of conservative U.S. stocks

RankCompanyTickerMarket Cap ($ Millions)Dividend Yield (%)5Yr Beta5Yr Standard Dev. of Monthly ROEIndustry Relative Earns Variability
1AT&T Inc.T-N 233,589.0 5.30.440.53-33.37
2Kinder Morgan Inc.KMI-N 40,019.4 3.60.612.30-31.59
3Digital Realty TrustDLR-N 22,964.4 3.3-0.060.73-1.99
4Federal Realty Invest. TrustFRT-N 9,578.4 3.00.370.42-14.26
5National Retail PropertiesNNN-N 6,529.2 4.40.390.29-13.44
6Senior Housing PropertiesSNH-Q 4,498.3 8.20.480.47-14.22
7Realty Income Corp.O-N 15,878.6 4.50.300.70-10.50
8Amdocs Ltd.DOX-Q 9,505.5 1.50.531.87-14.95
9Consolidated Edison Inc.ED-N 26,529.5
10Rollins Inc.ROL-N 10,227.4
11Stericycle Inc.SRCL-Q 5,786.6
12Under Armour Inc.UA-N 6,227.9
13Constellation BrandsSTZ-N 43,665.7
14CenturyLink Inc.CTL-N 18,600.7 12.40.792.04-19.00
15Southern Co.SO-N 49,990.7

Source: Morningstar Canada