What Is a Widow-and-Orphan Stock?
Let me explain what a widow-and-orphan stock is: it's an equity investment that typically pays a high dividend and is generally seen as low-risk. These are usually shares in large, mature companies operating in non-cyclical business sectors.
Key Takeaways
You should know that widow-and-orphan stocks are low-volatility investments that pay high dividends. They are traditionally associated with blue-chip companies in non-cyclical industries like consumer staples. Although the term isn't commonly used today, large-cap value investors often select stocks that fit this description.
Understanding Widow-and-Orphan Stocks
These stocks are typically found in non-cyclical sectors such as utilities and consumer staples, which tend to hold up better during economic downturns. For instance, many investors viewed AT&T before its 1984 government breakup as a widow-and-orphan stock, considering it lower risk and suitable even for vulnerable individuals.
Widow-and-orphan stocks generally offer low but steady returns, supported by their dividends or monopoly-like positions. In contrast, growth stocks with high price-earnings ratios that don't pay dividends are the opposite.
Fast Fact
Historically, dividends were seen as ideal for widows and orphans—those without the expertise or risk tolerance for aggressive momentum plays.
Special Considerations
Most investors regard regulated utilities as widow-and-orphan stocks because they trade in narrow ranges with lower volatility over market cycles compared to average stocks. They also often pay steady dividends supported by strong cash flows, leading to high coverage ratios due to their consistent earnings from stable customer demand, even in weak economies.
The drawback is that regulated utilities can't charge premiums during peak demand since government controls prices, and all rate increases require approval. Consequently, their earnings grow slowly, not as quickly as in non-regulated cyclical industries. This is why younger investors or those chasing higher returns often avoid them, while they attract those seeking steady income.
Pros and Cons of Widow-and-Orphan Stocks
Few people use the term widow-and-orphan stock nowadays; instead, they refer to these as low-volatility investments. To qualify, stocks usually have a beta well below 1. Some managers specialize in them, aiming to outperform low-volatility indices by choosing those with potential for higher dividend growth and price appreciation.
There can be short periods when even safe stocks in stable sectors increase market volatility rather than smoothing returns, causing them to underperform cyclical stocks.
Additionally, these stocks can't escape specific risks, like a consumer staples firm dealing with a major lawsuit or a utility facing a plant fire that disrupts operations for a long time.
It's also difficult to detect when executives use creative accounting to manipulate books, a tactic sometimes employed to meet profit targets fraudulently. This happened more in the late 1990s, but fraud can emerge in any sector over time.
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