The most widely available measure of volatility is beta. (You can find a stock’s historical beta at the Web sites I previously mentioned.) If a stock has a beta of less than 1, the share price has historically fluctuated less than the market.
I generally favor low-beta stocks because they let me sleep better at night. However, in the early stages of a bull market (as in 2009, for example), high-beta stocks will give you more punch on the upside. So it’s OK to own some high-beta stocks, too, but only when you’re pretty sure you’ve got the market’s wind at your back.
So After You Run the Numbers …
If it seems that the stock, at its present level, is unlikely to outrun the market indices over the next 12 months, I would advise buying below today’s price. (“Wait for a pullback” is the well-worn phrase.) On the other hand, if the stock appears capable of beating the indices from here on, it’s OK to buy even somewhat above today’s price.
A good way to get some idea of a stock’s near-term potential is to look at the analysts’ target price 12 months out. (As far as I know, the only website that provides this information is Yahoo Finance.) Let’s say the analysts are projecting $34.79 for Microsoft (MSFT) in 12 months and the stock is currently at $31.50. That means analysts are estimating a 10.4% price gain in a year. Add in a 2.9% dividend, and you get a total return of 13.3%.
For most stocks, I like to buy at a projected total return of at least 15%. (With utilities and other slow-and-steady movers, I may accept as little as 12%.) Thus, in the case of Microsoft, I would set my buy limit around $31 to nail down a projected return of 15%.
Subscribers occasionally express surprise when I lower a buy limit. It’s no mystery, though. Businesses, like people, run into unforeseen difficulties. If a company’s operating performance hits a rough patch, you can’t expect its stock to behave as well as it did before — certainly not until management takes steps to resolve the problem. In the interim, it’s only reasonable to demand a lower stock price to reflect the changed circumstances.
When deciding which of several recommended investments to buy, I suggest that you begin with the names furthest (in percentage terms) below your buy limit. If you’re looking to sell anything — perhaps because you need the cash, or because you like to trade more actively — start with the investments furthest above that limit.
By following a disciplined approach, you’ll put acres of daylight between yourself and the legions of investors who let their emotions rule.
Richard Band’s Profitable Investing advisory service helps retirement savers outperform the market without losing a minute of sleep along the way. His straightforward style and low-risk value approach has won seven Best Financial Advisory awards from the Newsletter and Electronic Publishers Foundation.
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