The main characteristics of conservative stocks are low volatility, long-term growth and low risk of capital loss. These businesses are usually established companies with a long and consistent record of sales and earnings growth. They have strong balance sheets, including healthy cash balances and low debt levels. Conservative stocks are particularly well suited for retirees, who are unwilling to tolerate excessive market volatility and cannot afford to lose money on their investments.
Safety of principal is important to retirees because they usually do not have the means to rebuild their investment portfolios should one or more holdings suffer significant price declines. Conservative stocks provide reasonable safety of principal because the businesses involved have a long record of meeting market expectations. In other words, investors typically do not deal with either positive or negative earnings surprises. The investors in these stocks tend to have long-term financial objectives. They generally do not respond to short-term market price moves or panic at the slightest bit of bad news. Low stock turnover usually means low volatility, which means stable prices even during market downturns.
Conservative stocks tend to pay dividends, which is of benefit to retirees who may not have any other source of income. Retirees may also benefit from a lower effective tax rate on dividend income. Investors need to monitor the financial health of all of their investments because a company's cash flow problems could lead to stock price declines and suspension or reduction of dividend payments. The yield of a dividend-paying stock is the preceding 12-month dividend payments divided by the current market price. Growth companies tend to have a low dividend yield because they reinvest their cash in operations, but mature companies with abundant cash flow tend to have high dividend yields.
Conservative companies usually take minimal risks because they focus on generating consistent cash flow. The stocks tend to be liquid, meaning there is always a sufficient number of buyers and sellers to ensure order fills. Therefore, if stocks see significant price appreciation, investors can reduce their positions in these stocks and buy those that may be trading below the industry price-to-earnings ratio.
While conservative stocks can benefit from safe-haven buying during market downturns, they tend to under-perform during rising markets because of relatively lower earnings growth potential compared to growth stocks. Retirees and other investors should periodically rebalance their portfolios to maintain the target asset mix. For example, if rising bond prices increases the bond weighting in a portfolio, investors could sell bonds and buy stocks to restore their target asset mix.
Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.