A dream for most investors is to retire early. However, one of the challenges in working towards that goal is deciding how much risk to take. For example, taking greater risk may improve long-term returns, but it can lead to increased volatility in the meantime. This may not sound so bad in theory (since it can mean higher returns), but even paper losses can be painful and cause investors to hang back on pumping cash into their portfolio at the most opportune moments.
Similarly, taking too little risk may provide a more certain shareholder experience, but the chances of retiring early may be held back by returns that are simply not high enough. As such, getting the right mix of risk and reward can be somewhat challenging.
However, stocks such as CSL Limited (ASX: CSL) appear to offer the perfect mix of the two. It operates in an industry that is inherently risky on the one hand, but which also offers superb defensive qualities, too. For example, the pharmaceutical sector is risky in terms of there being a need to constantly develop a pipeline of new drugs and have replacements ready for when key, blockbuster drugs lose their patents and become subject to generic competition. And, should there be no replacements, sales and profit figures can be severely revised downwards.
The pharmaceutical sector, though, also offers excellent defensive qualities. That's because it is less highly correlated with the performance of the ASX or with the wider economy than most companies, thereby providing something of a counterweight to a falling market. Evidence of this can be seen in the fact that, while the ASX has fallen by 7% in the last year, CSL is up by 25%. Certainly, CSL may trade on a price to book (P/B) ratio of 12 but, with earnings set to rise by over 12% per annum during the next two years, it appears to be an excellent long-term buy.
Similarly, rail freight operator, Aurizon Holdings Ltd (ASX: AZJ), also has an appealing risk/reward ratio. It has an excellent track record of earnings growth, with its bottom line rising at an annualised rate of 28.5% during the last five years. And, with a beta of 0.9, it should provide a less volatile shareholder experience moving forward. However, the company also has excellent potential rewards with, for example, its net profit set to rise by 9% per annum during the next two years. This rate of growth could stimulate investor sentiment and push Aurizon's P/B ratio of 1.68 even higher.
Meanwhile, Commonwealth Bank of Australia (ASX: CBA) continues to offer a potent mix of income, value and growth potential. Certainly, there were concerns raised about the prospect for dividend rises after regulators decided that major banks required a capital boost. But, with shareholder payouts set to rise by 3.7% per annum during the next two years, CBA's forward yield of 5.9% (using financial year 2017's forecasts) is likely to be well ahead of the ASX's yield moving forward. And, with CBA trading at a slight discount to the wider index, with a price to earnings (P/E) ratio of 14.3 versus 15 for the ASX, it seems to offer fair value, thereby making it a sound long-term income play to help you retire early.
