The Incredible Zero Beta Stock
How many times have you been at a party, a barbecue, or some other social function when the stock market is discussed? There is the obligatory “nattering nabob of negativity” that is typically incorrect. Generally it is one person, who is ill informed, stating rehashed lines that are chock-full of wealth-destroying advice. We have all heard Mr. Negativity say “the economy is lousy,” “the unemployment rate is too high,” or “the stock market is awful.” You would like to speak out against that individual, but just don’t feel prepared to counteract the standard refrain of “buy gold” or “put all your money in CDs.” Don’t you wish you had an investment that was easy to explain and could provide value to this misled individual? That investment is Dollar General (NYSE: DG). It is, in effect, the incredible zero beta stock.
Risk
Investing is nothing more than the balance between risk and reward. Discussing investing with anyone who does not understand this is the ultimate exercise in futility. Risk always has, and always will, exist in investing. The key is to properly categorize and quantify the risk. Risk is generally classified by systemic (total market), or idiosyncratic (individual company) risk. Mr. Negativity is basically stating there is too much systemic risk in the market for his liking. If only there was a way to quantify systemic risk...
Enter Beta
Beta is that quantifier; what it does is measure the movement of a stock versus the movement of an entire index. A stock with a beta of 2 will go up 20% if the index (typically the S&P 500) goes up 10%. High betas are usually associated with consumer cyclical goods and luxury goods, because individuals will splurge when the economy is good and cut down on purchases when the economy is poor. Low betas are typically indicative of consumer staples, because many individuals will “trade down” and increase purchases of these inferior goods in a poor economy--not to mention the fact that many consumer staples are items you cannot live without. A rare zero beta company has no correlation to the overall market; it is only affected by its own performance.
Dollar General
Dollar General is that company. Its beta ranges from zero to .05, meaning this stock is decoupled from the stock market and the overall economy. It is inoculated from the poor economy, thus properly rebuffing Mr. Negativity’s claims. Of course, Mr. Negativity will probably respond by stating, “Well, what if this company underperforms?” Recent history has shown that to not be the case.
Dollar General has grown net income from a loss of $4.8 million in 2008, to a $766 million gain in 2012. This has led the stock from a $0.02 EPS loss in 2008 to a $2.25 EPS gain in 2012. The company has slashed long term debt 40% during this period, and total debt by 15%. The following chart shows the tremendous growth in net income and free cash flow during this tough economy.
Other Asset Classes
If you are at Mr. Negativity’s event, you can agree with him on gold, to an extent. Gold is a great asset class to own for diversification, not a place to put your entire net worth. A great way to gain exposure to the gold market is the SPDR Gold Trust ETF (NYSEMKT: GLD). Anecdotally, real estate is a low beta investment as well, but hard to measure. In order to compare these investments, I decided to run a regression analysis to determine what the betas were on these alternative investments. The results were surprising, and will further give you the upper hand in your “friendly” discussion.
|
|
Beta |
3 Year Return |
|
Dollar General |
~0 |
123% |
|
Gold |
.23 |
67% |
|
Real Estate (Case-Shiller) |
(.01) |
(.16%) |
|
S&P 500 |
1 |
38% |
*Period July 2009-2012
As you can see, Dollar General trumps both gold and real estate as an investment over the last three years. Not only that, it also provides more protection from systemic risk. Gold has a weak, but statistically evident, correlation to the overall economy. Real estate actually has a negative correlation to the overall economy over the last three years, using the Case-Shiller 20 City Composite as a tracking index; but it has still underperformed Dollar General and the overall market substantially. If you think real estate is destined to outperform, but prefer the liquidity of an ETF, look into the iShares Real Estate Index Fund (NYSEMKT: IYR).
Foolish Conclusion
Mr. Negativity may be having a bad day, but don't allow him to have a bad portfolio. Over time, a diversified mix of high quality companies is the best wealth-creation vehicle in the world. While risk exists in investing, the key is properly categorizing and quantifying these risks. Finding a company with no systemic risk is a great start to a winning portfolio.
jcareagle has a position in Dollar General. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
