With risk a preoccupation in volatile 2010 investing, it shouldn't be surprising to hear a Wall Street pundit quoting tough-guy Clint Eastwood.
"A good man always knows his limitations," the actor, in his role as detective "Dirty Harry" Callahan, said bluntly to a commander who claimed never to have drawn a gun.
That line from the film "Magnum Force" suits today's market perfectly, believes Sam Stovall, senior investment strategist for Standard & Poor's Corp., in New York.
"If you think you can cope with volatility in today's market, but you can't, you need to either ignore your portfolio or invest in less volatile stocks," Stovall explains. "Find out who you are and if you can handle all the turns."
The price volatility of five of the 10 sectors of the S&P 500 stocks is currently at or near the all-time high of the past 20 years, he notes. Furthermore, none of the remaining five sectors have volatility levels below their long-term average. But while volatility is the first risk to consider, it's not the last.
"Companies carrying a lot of debt have interest-rate risk as their interest expenses go up with higher rates and impact their overall earnings," Stovall adds. "Next, there is dividend payment risk in terms of the size of the financial cushion a company has to meet its dividend obligations."
It should be reassuring that 53 times since 1945 the market has dropped by 5 percent to 10 percent, and on average it has subsequently taken just two months to break even. But rather than view a market decline as a time to buy, human emotion takes over, and investors bail out, Stovall says.
"I find it interesting that people start to freak out when the market drops 5 percent," says Stovall. "In this day and age of instant information, people seem capable of experiencing fear and greed at the same time."
As far as risk is concerned, confidence in dividends is Stovall's current solution.
There's less to worry about with companies that have consistently raised dividend payments in the past 10 years, have a stock yield of 3 percent or more, and have received favorable overall recommendations.
Those basic guidelines for low-risk investing apply to many stocks.
A recommendation in energy is oil and gas producer Chevron Corp. (CVX), he says. In financials, he likes the $61 billion-asset Hudson City Bancorp Inc. (HCBK) based in New Jersey; the payroll processing and benefits administrator Automatic Data Processing Inc. (ADP) in technology; and the natural gas and natural-gas liquids processor and distributor Oneok Inc. (OKE).
On the other hand, some examples of stocks to which he'd give a wide berth due to lack of dividend growth and other uncertainties are specialized chemicals firm Cytec Industries Inc. (CYT), real estate investment trust LaSalle Hotel Properties (LHO), and mortgage insurer Radian Group Inc. (RDN).
Lately, increased volatility has meant a stronger correlation in price movement of seemingly unrelated stocks than historically has been the case, observes Richard Cripps, chief investment officer of Equity Compass Strategies, at Stiefel Financial, in Baltimore.
That could be general overreaction to news events that move everything at once, but whatever the cause it makes diversification tougher and requires investor homework.
"While we see no financial risks for information technology companies, we see high financial risk for financial institutions (such as banks) because of their extraordinary reliance on capital markets," says Cripps. "The greatest financial-risk sectors would be financials at the top, followed by consumer discretionary companies, and then industrial companies."
The least amount of financial risk is in the stocks of IT companies because they don't carry much debt, electrical utilities because of their regulated environment, and consumer staples companies because they sell products that are constantly in demand, he says.
"In considering risk, you should always avoid company-specific risk in which you 'fly or die' by the performance of one stock," advises Paul Nolte, managing director of Dearborn Partners, in Chicago. "Investors frequently have big concentrations in a particular stock, which in some cases is an Enron or a BP, and that can be detrimental to your personal wealth."
While some bigger companies can encounter problems, as a group they tend to be the least risky, Nolte believes. That's because they are usually global in nature with broad product lines, stable earnings, revenue growth, good rising dividends each year, and reasonable stock prices, he says.
Some notable low-risk stock examples that Nolte points to are International Business Machines Corp. (IBM), Johnson & Johnson (JNJ), PepsiCo Inc. (PEP), Colgate Palmolive Co. (CL), and General Mills Inc. (GIS).
Not all investors view investment risk the same way, even if they may seem as tough as Clint Eastwood.
"I had a client who considered himself a risky guy because he drives race cars for a living, but when the portfolio dropped by 5 percent he was very concerned because he lost money," recalls Nolte.
"He felt comfortable driving his car because he understood it, but was uncomfortable in the investment field because he didn't understand it," he says.
A better knowledge of stocks and industries makes an investor's attitude toward risk much more reasonable, he concludes. Which is a good idea, since risk isn't about to vanish anytime soon.
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