You Snooze, You Win

While a lot of other investment newsletters promise excitement, we’d rather lull you to sleep.

At Investing Daily’s Utility Forecaster, we look for the best dividend-paying stocks from the world’s most boring companies.

That’s because when you depend on your portfolios to generate income, you don’t want any surprises—just steadily rising dividends (and steadily rising share prices to go along with them).

To that end, in the next issue of Utility Forecaster, we’ll be combing our coverage universe for the least risky stocks in a space that’s already considered the least risky sector of the stock market.

Among the factors we’ll be considering are traditional risk metrics, such as beta, standard deviation, and the Sharpe ratio.

We’ll also look at how companies held up during the last bear market, as well as during sector corrections.

To complete the picture, we’ll examine company-specific risks, such as leverage and the extent to which operations are fully regulated.

Our hope is to identify a handful of names that the most risk-averse income investors would be happy to hold through thick and thin.

The 1 Risk Metric That Nobody Talks About

As part of our research, we’ll also be using one obscure metric that most investors, even professionals, rarely talk about: The Sortino ratio.

The Sortino ratio is an intriguing variation on the standard measure of risk-adjusted return, which employs the Sharpe ratio.

The Sharpe ratio was created by Nobel Prize-winning economist William Sharpe to help investors determine how well they’re getting paid for enduring volatility.

First, it isolates the premium a stock generates above a risk-free return, such as the one from 90-day T-bills.

Then it compares that premium to the stock’s standard deviation, which measures the range of returns (from positive to negative) that a stock is expected to produce most of the time.

Some Volatility Is Good

The main problem with this metric is that volatility isn’t always a bad thing, especially when it’s to the upside. Indeed, the Sharpe ratio can penalize a stock that has significant upside volatility—the kind of volatility that investors actually want.

To rectify this shortcoming, an academic named Frank Sortino decided to create a variation on risk-adjusted return that contrasts investment performance to downward volatility alone.

The Sortino ratio replaces standard deviation with semivariance, which is a subset of standard deviation.

In fact, semivariance can be tweaked to include not just negative returns, but any returns below an investor’s minimum acceptable return. But in practice, most services simply focus on negative returns.

In screening the U.S. electric utility sector with the aforementioned criteria, we were heartened to see that many of our top portfolio holdings ranked highly, regardless of metric.

But one name consistently ranked in the top 10.

In addition to ranking 4th in terms of the Sortino ratio and also ranking highly according to the other volatility metrics, this utility also carries significantly lower leverage than its sector peers.

For instance, the utility’s net debt to EBITDA (earnings before interest, taxation, depreciation and amortization) stands at 2.9x, compared to a sector average of 4.1x, while debt to equity is at just 86.0% compared to an industry average of 123.6%.

The utility also has one of the strongest growth trajectories in the industry, which is expected to generate equally strong dividend growth of 10% annually through 2020.

In fact, this name also happens to be the latest addition to our Growth Portfolio and was featured as the Spotlight in our January issue.

There’s no way to mitigate all risk, especially for companies that own and operate massive infrastructure. But we’re happy to see that in recent years one of our new favorites has done a good job of keeping a lid on volatility.