For investors, there is a constant trade-off between risk and reward. At the present time it appears as though there are considerable risks ahead. For example, the Australian economy seems destined to move into a recession, since commodity prices are showing little sign of an improvement and the Chinese economy seems to be on a path to a slower rate of growth. As such, many investors may feel that buying shares at the present time is simply too risky.
However, at the same time the rewards are also considerable right now. Certainly, share prices have fallen this year, but a number of high quality stocks are now trading on appealing valuations which could equate to significant capital gains in future. And, moreover, dividend yields are likely to be juicier after a fall in share prices which could help to offset low interest rates.
Clearly, protecting the value of your hard-earned cash is important and, in this regard, the likes of Commonwealth Bank of Australia (ASX: CBA) and QBE Insurance Group Ltd (ASX: QBE) score highly.
That's at least partly because they are low beta stocks, which means that their share prices should (in theory) move by a smaller amount in the short run compared to the wider index. For example, CBA has a beta of 0.8, while QBE's beta is 0.55, and this means that for every 1% fall in the value of the ASX the two companies should post a fall in their valuations of 0.8% and 0.55% respectively.
Furthermore, as businesses they are performing relatively well, with QBE's turnaround plan set to deliver a rise in the company's bottom line of 31% this financial year and a further 20% in the next financial year. This has been stimulated by an operational transformation programme which has realised expense savings of $242m since it was launched in 2012. And, looking ahead to next year, QBE is expecting the plan to deliver a further $100m in savings as it continues to turn its business around from the loss-making company of just a few years ago.
Similarly, CBA is in a stronger financial position following its $5bn capital raising. Following this, CBA is now in the top quartile of international peers when it comes to capital ratios and, with liquidity of $132bn, has a liquidity coverage ratio of 120%, which is $22bn higher than regulatory requirements. Furthermore, CBA improved its cost:income ratio by 10 basis points to 42.8% last financial year, which shows that it is becoming increasingly efficient and that its relentless focus on costs is aiding its financial performance – as evidenced by forecasts for 6% per annum growth in earnings over the next two years.
Meanwhile, both QBE and CBA trade at discounts to the ASX, with them having price to earnings (P/E) ratios of 13.9 and 15.5 respectively, versus 15.6 for the wider index. And, with forward dividend yields of 5.5% and 6% respectively, they offer excellent income returns as well as the potential for capital gains.
