If politics keeps driving this market rally, then these dozen stocks could do well.
After several months of weakness, the London stock market is showing some recent strength.
As I write, the blue-chip FTSE 100 (UKX) index of elite UK-listed companies has risen by roughly 160 points since 28 June, which is an uplift of about 3% in seven trading days. This rise came about following an unusually successful euro-summit offering real concessions to struggling Italy, Spain and Ireland.
Central banks act
Nevertheless, growth in the UK and euro zone has been weak of late, so central banks once again rode to the rescue.
On Thursday, the European Central Bank (ECB) cut its main interest rate to 0.75% from 1% -- the lowest level since the ECB was established in 1998. Clearly, the ECB is pinning its hopes on lower borrowing costs leading to increased spending by individuals and higher investment by companies.
Here in Blighty, the Bank of England has less room to manoeuvre, having already cut its base rate to a mere 0.5%, the lowest level in the Bank's 318-year history. Thus, also on Thursday, the Bank revealed 'QE3' -- its third round of quantitative easing (QE), often dubbed 'money printing'.
On top of the £325 billion pumped into the economy by QE1 and QE2, the Bank has added another £50 billion in the form of QE3. Banks benefit greatly from QE, as it improves their liquidity and lowers their funding costs. Alas, QE harms pensioners by lowering annuity rates and may also push up inflation by increasing the money supply.
Another relief rally?
When the Bank launched QE1 and QE2, share prices rallied strongly for months afterwards. Hence, if QE3 gets a similar reception, then the London market may continue to build on its recent upswing.
However, which shares are likely to do best in steadily rising markets? The answer could be shares with 'high betas'.
Beta is a measure of an asset's volatility, relative to its wider market. For instance, a beta of below one means that a share is less volatile than the wider market. Similarly, a beta above one means a share tends to move up and down with greater volatility than its peers.
Therefore, shares with high betas tend to rise more quickly during market upswings, but dive more steeply when Mr Market is feeling gloomy.
Twelve high-beta Footsie shares
To find out more about blue-chip betas, I screened the FTSE 100 to find high-beta candidates. I found:
- 53 shares with a beta of one or more;
- 24 shares with a beta of at least 1.5; and
- 12 shares with a beta of 1.8 and above.
Hence, I'm going to take a look at the fundamentals of these 12 highest-beta candidates to see which stick out as potential bargains. Here are these 'dynamic dozen' stocks, sorted from lowest to highest beta:
| Company | Price (p) | Market value (£bn) | Beta | PER | Dividend yield | Dividend cover |
|---|
| Fresnillo (LSE: FRES) | 1,483 | 10.8 | 1.8 | 20.6 | 2.5% | 1.9 |
| IMI (LSE: IMI) | 839 | 2.7 | 1.8 | 10.0 | 3.9% | 2.6 |
| Aviva (LSE: AV) | 289.7 | 8.3 | 1.8 | 5.4 | 9.8% | 1.9 |
| Rio Tinto (LSE: RIO) | 3,064.5 | 44.5 | 2.0 | 7.0 | 3.3% | 4.3 |
| Eurasian Natural Resources (LSE: ENRC) | 420.8 | 5.5 | 2.0 | 6.0 | 3.6% | 4.6 |
| Xstrata (LSE: XTA) | 833.1 | 25.4 | 2.0 | 8.6 | 3.3% | 3.5 |
| Lloyds Banking Group (LSE: LLOY) | 30.25 | 21.4 | 2.1 | 13.9 | 0.2% | 36.0 |
| Royal Bank of Scotland (LSE: RBS) | 202 | 12.3 | 2.1 | 7.4 | 0.0% | N/A |
| Antofagasta (LSE: ANTO) | 1,113 | 11.2 | 2.2 | 11.6 | 3.2% | 2.7 |
| Barclays (LSE: BARC) | 164.55 | 20.6 | 2.4 | 5.8 | 4.2% | 4.1 |
| Kazakhmys (LSE: KAZ) | 730 | 4.0 | 2.4 | 5.4 | 2.5% | 7.4 |
| Vedanta Resources (LSE: VED) | 913.5 | 2.8 | 2.6 | 4.7 | 3.9% | 5.5 |
Unsurprisingly, this table of high-beta shares lists companies with high recovery potential if and when the UK and global economies improve. It contains seven mining firms, three banks, one insurer (Aviva) and one engineer (IMI).
For today's exercise, I will not simply single out those shares with the highest betas. After all, if the market goes into reverse, then these stocks should suffer most. Hence, I will choose five stocks which have both high betas and value characteristics to protect investors' potential downside.
Five big names to watch
I tend to avoid companies with double-digit PERs (price-earnings ratios), which eliminates four firms. Also, I will reject RBS, because of its lack of a dividend, plus Rio Tinto and Xstrata, as their dividend yields (both 3.3%) are below the market average.
This leaves the following five high-beta shares with value features (in A-Z order):
1. Aviva (beta of 1.8)
On a forward PER of 5.4 and a prospective dividend yield approaching 10%, Aviva certainly looks cheap as chips to me. Also, it's just announced a major restructuring aimed at improving its returns on capital. This is surely a share for dividend devotees and deep-value diggers.
2. ENRC (beta of 2.0)
This is a very racy stock and, therefore, not one for widows and orphans to pile up. I say this because ENRC operates in the 'Wild East' of mining (in former Soviet states) and has had more than its fair share of corporate-governance run-ins. With a PER of six and dividend yield of 3.6%, it trades at 'danger money' levels, but this rating has room for future improvement.
3. Barclays (beta of 2.4)
Barclays, its management and share price has been under the cosh since last week, when it admitted to manipulating Libor. If you think this news has harmed the bank's business model as badly as it has hit its reputation, then you should steer well clear of Barclays.
Then again, if you think a PER of 5.8 and dividend yield of 4.2% sound appealing, then you may be able to look beyond recent events and play the long game by buying into a battered Barclays.
4. Kazakhmys (beta of 2.4)
Being in the same sector and ex-Soviet geography as ENRC, Kazakhmys comes with similar warnings. Even so, it trades on a PER of 5.4 and offers a modest dividend of 2.5%, making it the lowest-yielding of my five high-beta firms. In fact, I would have left out Kaz on dividend grounds, had it not been for its very high dividend cover (a whopping 7.4 times) offering high upside for increased cash payouts.
5. Vedanta (beta of 2.6)
Lastly, another miner, this time Indian giant Vedanta, a leading producer of copper, zinc, aluminium and iron ore with interests in the energy market.
Vedanta was once my largest-ever shareholding, so I can vouch for its volatility. In the time I owned it, Vedanta's share price went from £10 to £27, before later collapsing to below £4 and then back up to £30! Right now, this Indian jewel trades on an ultra-low PER of 4.7 and offers a prospective dividend yield of 3.9%.
What next?
Of course, what remains to be seen is if the recent market rally has legs and will continue, or whether it will run out of steam and stumble before reversing. For the answer to this particular riddle -- as always -- please consult your crystal ball!
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More from Cliff D'Arcy:
> Cliff does not own any of the shares mentioned in this article.
