Others are willing to take on additional risk for the chance of increased rewards. Every investor needs to have a good understanding of their own risk tolerance and a knowledge of which investments match their risk preferences. Many young technology companies that trade on the Nasdaq stocks have a beta greater than 1. This suggests that it acts independently of the overall stock market. Beta particles have a mass which is half of one thousandth of the mass of a proton and carry either a single negative (electron) or positive (positron) charge. As they have a small mass and can be released with high energy, they can reach relativistic speeds (close to the speed of light).
This allows you to see how the stock and index prices moved in relation to one another, relative to how the index price moved on its own. If you’re investing for the long term, you may want to factor in a time frame of about five to 10 years. If you’re a trader who buys and sells on a regular basis, consider using a few days or weeks. So if you’re examining the stock of a a large U.S. company, a good choice would be the S&P 500. This market index covers the 500 U.S. companies with the largest market capitalization.
But broadly speaking, the notion of beta is fairly straightforward. It’s a convenient measure that can be used to calculate the costs of equity used in a valuation method. A low-beta stock is in a company or industry that is perceived as less sensitive to the factors that affect stock prices in general or is even likely to move in the opposite direction. Once you’ve calculated the beta of a stock, it can then be used to tell you the relative correspondence of price movements in that stock, given the price movements in the broader market as a whole. High β – A company with a β that’s greater than 1 is more volatile than the market. For example, a high-risk technology company with a β of 1.75 would have returned 175% of what the market returned in a given period (typically measured weekly).
- Likewise, a small hint of good news can lead to another big rally.
- Beta is a measure of a stock’s volatility in relation to the overall market.
- Covariance is a measure of how two securities move in relation to one another.
- A company stock with beta less than one is called a defensive stock.
- Balancing high and low-beta assets allows investors to tailor their portfolios to their specific risk-reward preferences.
What are Equity Beta and Asset Beta?
The market index to which a stock is being compared is affected by market-wide risks. A beta value of more than 1.0 implies that the stock will be more volatile than the market, while a beta value of less than 1.0 predicts lower volatility. In a bull market, a beta above 1.0 will likely produce better returns but also come with more risk.
If you’re looking for something more exciting, then consider a stock with a value of above 2.0. Andy Smith is a Certified Financial Planner (CFP®), licensed realtor and educator with over 35 years of diverse financial management experience. He is an expert on personal finance, corporate finance and real estate and has assisted thousands of clients in meeting their financial goals over his career.
Anything that can affect the market as a whole, good or bad, is likely to affect a high-beta stock. A Federal Reserve decision on interest rates, a tick up or down in the unemployment rate, or a sudden change in the price of oil, all can move the stock market as a whole. This can be achieved by obtaining other stocks that have negative or low betas, or by using derivatives to limit downside losses. Systematic risk, or total market risk, is price volatility that affects stocks across many industries, sectors, and asset classes. Risks that affect the overall market are by their nature difficult to predict and hedge against. Let’s say the beta value of the entire stock market, as measured by an index, is 1.
Performance Prediction
For example, the Great Recession was a form of systematic risk. The economic downturn affected the market as a whole and brought down the prices of most individual stocks. In CAPM, Beta is used to calculate the expected return of an asset based on its risk compared to the market. Beta focuses on market risk and does not account for company-specific risks, such as management changes, product launches, or operational issues. These risks can impact a stock’s performance independently of the market. Beta is just one of many numbers that stock analysts and investors look at when evaluating a potential buy.
What affects beta of a stock?
A stock with a beta greater than 1 may indicate that it’s more volatile than the market. However, this could also mean it has the potential for stronger returns. Say your benchmark, or the market to which you’re comparing a stock, is the S&P 500. If the stock you’re analyzing has a beta of 2, that means the stock is twice as volatile as the market. If the S&P 500 goes up by 10% next year, you can expect the stock price to go up by 20%. However, it could plummet by just as much if the S&P 500 goes down by 10%.
If you think about risk as the possibility of a stock losing its value, beta has appeal as a proxy for risk. Think of an early-stage technology stock with a price that bounces up and down more than the market. It’s hard not to think that stock will be riskier than, say, a safe-haven utility industry stock with a low beta.
Is beta attracted to positive or negative?
For most investors, downside movements are a risk, while upside ones mean opportunity. Besides, beta offers a clear, quantifiable measure that is easy to work with. Sure, there are variations on beta depending on things such as the market index used and the time period measured.
Is a Zero beta portfolio good?
- If you’re a trader who buys and sells on a regular basis, consider using a few days or weeks.
- Investors with low tolerance for volatility would be happy with a stock that has a beta value of 1 or lower.
- Betas larger than 1.0 indicate greater volatility, and betas less than 1.0 indicate less volatility.
Estimators of market-beta have to wrestle with two important problems. First, the underlying market betas are known to move over time. Second, investors are interested in the best forecast of the true prevailing beta most indicative can beta be negative of the most likely future beta realization and not in the historical market-beta.
These kinds of stocks historically tend to not fluctuate much in value. They are companies that consistently deliver steady revenues and profits in times of economic expansion and hardship. Positive or negative surprises are lacking and valuations are based on very realistic expectations that the company has a history of reaching.
If beta is less than one, the returns on the company stock are less volatile than the market return. A company stock with beta less than one is called a defensive stock. A negative beta coefficient does not necessarily mean absence of risk.
Balancing high and low-beta assets allows investors to tailor their portfolios to their specific risk-reward preferences. Investors keen to bag big capital gains or day traders looking to make a quick buck from fluctuating share prices would be more interested in high-beta stocks. The share prices of these companies historically have a tendency to jump around quite a bit. Racy stocks, such as tech upstarts with the potential to revolutionize how certain things are done, fall into this category. Investing in one could make you a fortune or lead to big losses. Their future is unpredictable and that leads to lots of speculation and price movements.
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A beta of «0.00» on Yahoo! Finance means that the stock is either a new issue or doesn’t yet have a beta calculated for it. Many brokerage firms calculate the betas of securities they trade and publish their calculations in a beta book. These books offer estimates of the beta for almost any publicly-traded company.