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Why Low Risk Does Not Mean Low Returns

risk cubes dice

Last week, I debunked a classic saying that goes, “The stock market is the biggest casino in the world”. This week, let’s see if another well-known investing maxim, “The lower the risk, the lower the returns”, holds any water in the world of stocks.

Defining risk

In the world of finance – or at least what’s taught in finance and business schools – it’s a common notion to define risk in terms of “beta,” which is a measure of a financial instrument’s volatility. The more volatile an instrument is, the higher its beta and thus the risker it is.

Although some might frown at Wikipedia being used as a source of information, in the case of trying to define beta, it actually does a pretty good job. Here is Wikipedia explaining the concept:

“[The beta of] an investment is a measure of the risk arising from exposure to general market movements as opposed to idiosyncratic factors. The market portfolio of all investable assets has a beta of exactly 1. A beta below 1 can indicate either an investment with lower volatility than the market. An example is a treasury bill: the price does not go up or down a lot, so it has a low beta. A beta above one generally means that the asset both is volatile and tends to move up and down with the market.”

In Singapore, the general market is popularly represented by the Straits Times Index (SGX: ^STI). Thus, it is assigned a beta of one by definition. Any share that has a beta lower than that of the STI will be deemed as less risky than the general market. The reverse is also true – any share with a beta higher than one is looked upon as riskier than the market.

Revisiting five shares with ten-bagger returns

Last year, my Foolish colleague, Ser Jing, revealed five companies that had produced gains of 1,000% or more from 2003 to 2013.

The firms discussed in the article were food and beverage purveyor Super Group Ltd. (SGX: S10); engineering outfit Boustead Singapore Limited (SGX: F9D); conglomerates Jardine Strategic Holdings Limited (SGX: J37) and Jardine Matheson Holdings Limited (SGX: J36); and retailer, Dairy Farm International Holdings Ltd (SGX: D01).

Let’s revisit those companies and look at their respective betas and total returns.

Company Beta* Total return from 2004 to 2014**
Super Group 0.59 842%
Boustead Singapore 0.23 856%
Jardine Strategic Holdings 0.72 921%
Jardine Matheson Holdings 0.46 787%
Dairy Farm International 0.73 806%

*5-year historical beta as of 1 January 2004.
**Total return figures include reinvestment of dividends;  data from 1 January 2004 till 29 August 2014

Source: S&P Capital IQ

During the same period, the STI only added 79.7% in total. All of the shares had a beta of less than one back in January 2004, which meant that they were less risky than the market in general. If investors follow the notion of “the lower the risk, the lower the returns”, it would have meant that the quintet would be generating lower returns than the general market. Yet, as we have seen, that is not the case. In fact, the shares have all gained multiples of their initial value and did much better than the STI. Interestingly, the share with the lowest beta, Boustead, had produced the highest returns.

Foolish Takeaway

Sometimes, we need to challenge popular notions surrounding the stock market. Low risk does not mean low returns at all, as just seen above. Similarly, high risk does not automatically entail high returns too.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Sudhan P owns shares in Super Group Ltd and Boustead Singapore Limited.