Investing in the stock market is often compared to gambling. This analogy became particularly popular in the wake of the 1973 publication of Burton Malkiel’s A Random Walk Down Wall Street, which argued that the movement of asset prices is just, well, too random to outperform on a consistent basis. Most of the time, an active investor employing the tools of technical or fundamental analysis, the hypothesis goes, will underperform a passive investment strategy.
And this is exactly what is observed in the real world: Most money managers underperform the market in the long run. According to an analysis by NerdWallet, actively managed funds underperformed the market by an average of 0.56 percent (median of 1.36 percent) in the 10-year period ended December 2012. Even more to the point, a December 2013 study released by the National Bureau of Economic Research found that the average Sharpe ratio for all mutual funds that have been in existence for 30 or more years is 0.37, which compares unfavorably to the S&P 500 at 0.39.
The Sharpe ratio measures the risk-adjusted performance of an investment and can be used as a way to gain insight into where the returns are coming from in a portfolio. Two portfolios with with the same returns could have very different Sharpe ratios if one made risky bets and got lucky, and the other made safe bets that produced superior returns. A high Sharpe ratio is arguably the Holy Grail of investing: low risk, high reward. Or, at least, high reward relative to risk.
With the random walk theory in mind, it may seem like investments with high Sharpe ratios are rare. This is true to a degree, but these investments do exist, and a few enterprising money managers have developed strategies to capitalize on them. Take, for example, Warren Buffett. According to the NBE study, Buffett achieved a Sharpe ratio of 0.76 for the same 30-year period, during which the average mutual fund manager underperformed the market.
So somewhere out there in the world of equities there are Holy Grail investments. It flies in the face of conventional wisdom like the mantra of the high-return tradeoff (high risk, high reward), but the data don’t lie. Here are a couple of stocks that could fit into such a strategy.
1. Kimberly-Clark Corp. (NYSE:KMB)
Kimberly-Clark is a personal care company that routinely finds itself in lists of top investments, and for good reason. The company is a prime example of a low-volatility stock that has managed to pace or outpace market growth over long periods of time while maintaining a low beta.
Shares have increased nearly 120 percent over the past five-year period and about 73 percent over the past 10-year period, slightly higher than the S&P 500 during the first period and on par in the second. With a beta of about 0.25, this growth has been about as stable as possible, and the company has helped lock in long-term investors with a healthy dividend yield of 3 percent — a dividend that has increased each year since 1972, at that.
Kimberly-Clark owns the brands behind dozens of consumer staples such as Kleenex, Huggies, Scott, and Cottonelle. According to the company’s year-end 2013 results, Kimberly-Clark brands hold the largest or second-largest share of markets in more than 80 countries.
Full-year 2013 sales of $21.2 billion were “essentially even” with 2012, although organic sales increased 4 percent (3 percent volume and 1 percent net selling price growth). Sales growth is expected to contract 1 percent this year, according to a company forecast, but earnings are expected to continue increasing as operating margin expands. Kimberly-Clark forecasts adjusted earnings in a range between $6 and $6.20 per share, up 4 to 7 percent on the year.
2. Costco Wholesale Corp. (NASDAQ:COST)
Costco has not only outperformed the market at low volatility, but it’s done so with style. Shares of the discount retailer are up 160 percent over the past five-year period and 225 percent over the past 10-year period, outpacing the S&P 500 in both periods. With a beta of 0.42, volatility is low.
Costco, a big-box retailer blessed with a strong business model, market leadership, and competent executives, pays a starting wage of $11.50 per hour. If you ask CEO Craig Jelinek, he’s likely to attribute at least some of his company’s success to that fact.
“An important reason for the success of Costco’s business model is the attraction and retention of great employees,” he said in a statement last year. “Instead of minimizing wages, we know it’s a lot more profitable in the long term to minimize employee turnover and maximize employee productivity, commitment and loyalty.”
Costco will report earnings at the end of May, and the market appears to be getting increasingly optimistic about the announcement. The retailer recently announced that net sales for the four weeks ended May 4 increased 7 percent on the year to $8.56 billion. Comparable sales were up 5 percent over the same period.
3. General Mills Inc. (NYSE:GIS)
General Mills is a food company perhaps best known for iconic brands like Cheerios, Haagen-Dazs, Green Giant, and Lucky Charms. Like Kimberly-Clark, General Mills has built itself an empire of leading consumer staples. Shares have climbed more than 106 percent over the past five years and 136 percent over the past 10 years, lagging the S&P 500, but not by much. With a beta of 0.22, volatility has been relatively low.
Besides low volatility, General Mills offers a high dividend yield of 3 percent, currently $1.64 per share. Because of this and its strong record of growth, the company has been considered one of the best bets in the consumer sector, and analysts are expecting more good things in the coming quarter. Earnings are expected to increase 36 percent on the year to 72 cents per share, while sales are expected to edge 0.4 percent higher to a mean analyst estimate of $4.43 billion.