Stocks are winners when Wall Street agrees

  • By Al Root,
  • Barron's
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Sometimes Wall Street analysts can’t agree on a stock—and long-term investors might want to stay away when that happens. (Because Barron’s found volatility picks up without any compensation for added risk in the form of higher returns.) Sometimes, however, Wall Street analysts agree on a stock—and that seems to be a recipe for lower volatility as well as higher returns.

Most of the time, there is a healthy level of disagreement among analysts when valuing companies they cover. The average difference between the highest and lowest price targets for stocks in the Dow Jones Industrial Average (.DJI) amounts to about 40% of the current stock price. What’s more, about half the time analysts say Buy a stock while the other half aren’t recommending purchase.

Barron’s found 36 companies in the S&P 500 (.SPX) —including Google parent Alphabet (GOOGL) and Berkshire Hathaway (BRK/B)—with high-to-low price target spread less than 20% of the current stock price, about half of what is normal. Investors might think that means there isn’t much opportunity in those stocks. After all, investors need a little uncertainty to be able to make money—that’s the way risk works. And if everyone agrees on corporate risks and outlooks it should be reflected in the stock price. But turns out, that is not the case.

The 36 no-controversy stocks have returned about 13% a year, on average, for the past five years, better than the 11% return of the S&P 500 over the same span. What’s more, the average peak-to-trough move in the no-controversy stocks over the past year is about 25% of the current stock price, versus 40% for everything else.

Higher return with lower risk sounds like a “free lunch.” Equity investors, however, are paying up for the lower risk. The no-controversy stocks trade for about 22 times estimated earnings, higher than the 16 times valuation multiple for everything else. Still, higher valuation multiples for no-controversy stocks haven’t hurt returns over the past few years.

McDonald’s (MCD) is the poster child for the group of no-controversy stocks. Price targets, among larger brokerage firms, range from $200 to $230 a share, or $30, only about 14% of the current stock price of roughly $211 at Friday’s close. McDonald’s share have ranged from about $153 to $213 over the past year and the stock has returned more than 20% year to date. It trades for about 24 times estimated earnings, a 50% premium to the overall market. Despite the premium valuation, investors like McDonald’s defensive characteristics as well as plans to refresh restaurants and its menu.

Of course, no-controversy stocks could be come more controversial, which is something investors should watch out for. Alphabet, for instance, along with its social media competitors, is facing new privacy regulations around the world. And drugmaker Merck (MRK), like other pharmaceutical companies, is facing pressure from the U.S. government to decrease drug pricing.

The outlooks for some other no-controversy stocks shouldn’t change much. Berkshire, for instance, while Warren Buffett is at the helm, will always have a giant cash hoard. The company has about $240 billion in more cash than debt on its balance sheet, about 45% of the total market capitalization. All that cash makes the stock less volatile. And Evergy (EVRG) is another no-controversy stock. It is a utility yielding about 3.1%. Most utility stocks have lower than average volatility and trade, in part, based on the direction of U.S. interest rates.

Big opportunities usually emerge from big risks. But in this case, at least based on the recent past, investors can eat their cake and have it too.

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