Treynor Wheels for Judging Risk
By Michael Kaye
Risk-aversion is a fact of life for many investors after the stock market convulsions of the past few years. Clearly, it's more important than ever to reconcile the return on an investment with the degree of risk taken on in adding it to your portfolio.
This week, we've decided to spotlight a venerable, though lesser known, measure of an investment's risk-adjusted performance: the Treynor ratio. Developed some four decades ago by researcher Jack Treynor -- who also contributed to the development of the Capital Asset Pricing Model and the Black Scholes Option Model -- this indicator measures the return on an investment minus the risk-free rate of return (defined as the yield on the three-month Treasury bill) divided by the stock's beta, a widely used volatility measure.
The resultant ratio indicates the investment's risk premium return per unit of risk. Simply put, larger values for the ratio indicate returns over a three-year period of time that have exceeded those of the overall market -- and with lower risk. All risk-averse investors would prefer to maximize this value.
As a starting point for this week's screen, we used the list of those stocks carrying Standard & Poor's top investment rankings: 4 STARS (accumulate) and 5 STARS (buy). Stocks with those rankings are expected by Standard & Poor's analysts to outperform the overall market over the next 6 to 12 months. We then looked for issues that had the highest Treynor ratio values, based on the past three years' worth of data.
When we ran the numbers, these 14 names scored the highest:
• Chelsea Property Group (CPG )
• Indymac Bancorp (NDE )
• Teva Pharmaceutical (TEVA )
• Chico's FAS (CHS )
• Nautilus Group (NLS )
• Exelon (EXC )
• Entergy (ETR )
• Weingarten Realty (WRI )
• TXU (TXU )
• Philadelphia Suburban (PSC )
• Amsurg (AMSG )
• Career Education (CECO )
• Christopher & Banks (CBK )
• U.S. Physical Therapy (USPH )
Kaye is a portfolio services analyst for Standard & Poor's