Do what Buffett does: Buy low-beta stocks

M the name SG

Picking stocks that are less volatile but offer good dividends is one way to improve your returns

Mr Buffett picks his stocks for the long haul, earning large returns along the way.

Goh Eng Yeow
Senior Correspondent

A recent article in The Economist that sought to explain the phenomenal success enjoyed by legendary investment guru Warren Buffett in his stock picks caught my eye.

What got me - and no doubt every other keen investor - interested was whether Mr Buffett's strategies could be adopted successfully by other investors eager to improve their returns.

A saver earns almost nothing keeping his money in the bank, which offers next-to-nothing interest rates, so we must consider other ways to put our money to work, such as investing in the stock market.

Unfortunately, there is no such thing as a crash-proof stock. Thus, an investor must choose strategies that keep his money safe and earn decent returns without taking unnecessary risks.

Sure, many would regard Mr Buffett as a statistical outlier, whose stock-picking skills are impossible to emulate. However, according to The Economist, a new paper from researchers at New York University and AQR Capital Management seems to have identified the main factors behind Mr Buffett's extraordinary success.

The researchers have found that, for Mr Buffett, one winning formula lies in buying into "low-beta" stocks. For the uninitiated, a stock's beta refers to its sensitivity to market movements.

If a stock moves in tandem with the market, it is assigned a beta of one. If it moves more violently than the market (rising by 10 per cent, for example, when the index goes up only 5 per cent), it is viewed as having a high beta, exceeding one in value. Similarly, a stock that moves less violently than the market has a low beta, dropping below one in value.

The Economist said: "Mr Buffett is well-known for buying shares in high-quality companies when they are temporarily down on their luck, such as Coca-Cola in the 1980s after the New Coke debacle or General Electric during the financial crisis in 2008."

If you have been tracking the stock market closely, you will realise that this approach is contrary to the one adopted by many big-time traders and hedge fund managers.

For them, the road to riches lies in picking high-beta counters such as penny stocks, for which double-digit gyrations in percentage terms are commonplace. These traders want to ride the momentum that is causing the prices of such counters to surge without worrying about the underlying business fundamentals of the companies.

Yet, as Mr Buffett has noted, such a strategy could prove to be extremely risky if the momentum fuelling the rally screeches to a halt. "It's only when the tide goes out that you learn who's been swimming naked," he once said.

Those who feel that Mr Buffett's strategy might be suitable for them can check out a stock's beta and other financial information through websites such as Reuters.com. The data is freely available on the Internet.

If you look at the betas of the 30 component stocks of the Straits Times Index (STI), you will find that some of its better performers this year have betas of less than one. These counters are also good dividend paymasters.

For example, ComfortDelGro has a beta of 0.52 and offers a dividend yield of 3.8 per cent. Its share price has risen 19 per cent since January.

StarHub, which has an even lower beta of 0.34 and a dividend yield of 5.4 per cent, has gone up about 28 per cent.

If you feel that local blue chips are now too pricey for your liking, following the STI's 16 per cent run-up this year, you can look further afield.

The appreciation of the Singdollar against major currencies such as the greenback and the euro means you will get more bang for your dollar if you buy into international blue chips.

Further, London and New York have low-beta blue chips that are trading at 10 to 12 times price-to-earnings ratios because they have been neglected by global investors in the wake of the European debt crisis.

For example, "sin" stocks with global brand names such as the shares of cigarette maker British American Tobacco and Dutch brewery giant Heineken trade with low betas of less than one.

Yet, these companies are good dividend paymasters whose business franchises are expanding their footprints aggressively in the developing world.

Then there are household names such as beverage giant Nestle and consumer goods maker Unilever, whose products populate the shelves of supermarkets all across Asia.

Their stocks are also low-beta and they offer a decent dividend payout.

If you can be as patient as Mr Buffett, who reputedly holds stocks for decades, you might find it rewarding to buy into low-beta stocks that are backed by powerful business franchises.

Investing your money this way could be more fruitful than leaving it in the bank.

invest, The Sunday Times, October 7 2012, Pg 45