Some stocks cope with volatility better than others

Leanne Pan, 14 January 2015

The early signs are that stock market volatility will continue in 2015.

This can mean a nervous time for investors, but it’s important to remember that markets never go up in a straight line – in fact markets may experience significant falls on the way up to higher highs.

While no stock is completely immune, sound stock selection can leave you better placed. We saw that even quality, well-run businesses with strong financials still suffered during the GFC but those same stocks were able to bounce-back and outperform again once conditions improved.

How we pick those stocks comes down to many factors, and there are no guarantees, but the following four characteristics may signal a stock is better placed to ride out volatile markets.

One – Quality counts:

Quality companies with good management, earnings and strong financials will usually bounce back eventually. But poorly managed stocks may experience a prolonged decline. In some cases, volatility will expose a poor business model or financing problems and the company may be worthless, as we saw with ABC Learning and Babcock & Brown.

Two – Higher certainty of return:

Companies with a history of paying healthy dividends are better positioned. Dividends offer a more stable element to overall portfolio returns. In an environment where capital return is questionable, income return is much more predictable and valued. As long as the companies are in reasonable shape, they do not tend to adjust dividends.

Paying consistently good dividends may indicate more certainty in company direction. The caveat is genuine stability and quality in the company and its management.

Three – Consider stocks with a strong asset backing:

Companies with solid asset backing tend to give a ‘safety buffer’ provided one is mindful of the asset make-up. A good valuation limits the downside during volatility. But you need discipline because it is not a question of paying 30 times P/E when another name is trading at 40 times P/E.

Four – The defensive approach – companies which thrive in tough conditions:

Investors may consider stocks which actually do better when the market environment is tough. Healthcare, aged care, food, telephone, utilities are all the necessity of life. They might be ‘boring’ in good times but allow you to sleep at night during volatile times.