High-return investments are appealing, but high-risk-adjusted-return investments are even more valuable. While risk can be challenging to measure, investors often use volatility as a proxy. In this approach, stocks with larger and more frequent price swings—both upward and downward—are considered riskier.
One way to measure a stock's risk-adjusted returns is to subtract the risk-free rate from its return over time. Then, divide that result by its volatility over that period. Investors know this as the Sharpe ratio, which shows how much return an investment generates for each unit of risk involved.
One practical reason this is important is that stocks that move wildly can cause investors to panic. This can lead them to sell despite the stock going up because they believe the next day could wipe out those returns. However, stocks that rise with limited volatility make investors more optimistic about holding.
Below, I’ll look at three stocks in the S&P 500 that have generated among the highest risk-adjusted returns over the past six months. I’ll use a 6-month U.S. Treasury yield of 4.4% as the risk-free rate. All the return figures are as of the Dec. 2 close.
Palantir: The Best Sharpe Ratio in the S&P 500
First is Palantir (NYSE: PLTR). Although the stock’s volatility is much higher than most in the S&P 500, it is making up for that with how much it is rising. Shares have provided a total return of 206% over the past six months. This gives it the highest Sharpe ratio of any S&P 500 stock during this period of 3.3. Palantir has been arguably the hottest large-cap stock lately. Its AI-driven solutions are in high demand.
It first became known for working with the U.S. government but has expanded its business to more companies through its Artificial Intelligence Platform (AIP). Its revenue from U.S. commercial enterprises has grown rapidly, up 54% last quarter. This nicely complements the 40% revenue growth from the U.S. government. This has helped the company beat estimates on sales and adjusted earnings per share (EPS) in every 2024 quarter. The company saw its shares rise 35% through the three days after its last earnings release. Additionally, there has been significant movement in the stock recently as the company expects to become eligible for inclusion into the NASDAQ 100 Index.
Targa: Natural Gas Company Experiencing Strong Demand
Targa Resources (NYSE: TRGP) has generated a total return of 66% over the last six months but has done so with a middle-of-the-pack level of volatility. This has given it a very high Sharpe ratio of 2.5. Targa is a midstream energy company. It specializes in gathering, processing, transporting, and storing natural gas and liquid natural gas. The company is seeing strong demand for its natural gas. Natural gas inlet volumes in the Permian Basin increased 18% last quarter, and the company transported a record level of natural gas.
The company is also getting new plants online and expanding old plants, showing the robust demand for its product. It continues to invest in projects to expand its capacity. The potential revenue growth from the new plants excites investors. The company also announced it expects to massively increase its dividend by 33% in 2025 compared to 2024. This provides confidence in the company’s financial situation and shows its willingness to reward shareholders.
Fair Issac: FICO Score Inventor with Fantastic Risk-Adjusted Return
Last is Fair Isaac (NYSE: FICO). This stock’s impressive return of 81%, combined with its also middling level of volatility, has allowed it to achieve a Sharpe ratio of 2.8 over the past six months. Fair Isaac is a data analytics company that became famous due to its creation of the FICO Score. The FICO Score is a credit rating for individuals. It's a key factor financial institutions consider when someone applies for a loan. The score has a near-ubiquitous use across the economy, giving Fair Isaac a strong competitive advantage.
The company has seen strong revenue growth in its Scores segment, which increased by 28% and 24% in fiscal Q3 and Q4, respectively. Its adjusted EPS also rose impressively by 31% last quarter. Americans taking out record amounts of credit card debt has increased the demand for the company’s scoring.
