Stock Beta is a calculation or measurement
of volatility or risk of a stock trading on the stock
market. It is the fluctuation in stock prices and the
market in general. Some stocks have greater risk than
others, and thus carry higher Stock Betas. Stock betas
are measured using regression analysis.
A Stock's Beta is the middle line between
minimizing the risk of undertaking investment activities
and maximizing the returns gained. For example, consider
a high-tech stock with a Beta of 2. This means the stock
is twice as volatile as the market. Therefore:
Stock
Beta = 2 |
| Market %
Return |
Individual
Stock % Return |
| 10% |
(10% x 2) = 20% |
| -8% |
(-8% x 2) = -16% |
If the market provides a 10% return
to ordinary investors, the stock with a Beta of 2 will provide
a 20% return (higher risk, higher return!). However, if
the market provides a negative 8% return, then the Stock
with a Beta of 2 will provide a -16% (higher risk, probability
of lower returns!).
Here's another example, with a stock
that has a Beta of 0.5
Stock
Beta = 0.5 |
| Market %
Return |
Individual
Stock % Return |
| 10% |
(10% x 0.5) = 5% |
| -8% |
(-8% x 0.5) = -4% |
If the market provides a 10% return
to ordinary investors, the stock with a Beta of 0.5 will
provide a 5% return (lower risk, lower return!). However,
if the market provides a negative 8% return, then the Stock
with a Beta of 2 will provide only a -4% loss, (lower risk,
lower returns!).
Analysis of Common Stock Betas
| Negative
Beta |
Shows an
inverse relation to the stock market and is highly unlikely.
Gold Stocks though fall into this category. |
| Beta of 0 |
Value of current cash
(with no inflation) has a Beta of 0. No matter how the
market performs, idle cash sitting always remains the
same (with no inflation). |
| Beta 0 -
1 |
These stocks are less
volatile than the stock market in general. Commonly
includes utility company stocks. |
| Beta of
1 |
A Beta of 1 means the
stock market is moving in the same direction as the
Market Index such as S&P 500. |
| Beta >1 |
Stocks with a Beta of
>1 are more volatile than the stock market. This
commonly includes high-tech stocks. Why? This is because
as technology becomes rapidly advanced, outdated technology
is useless. Many companies are thus wiped out due to
out-dated technology. |
| Beta >100 |
This is impossible.
A stock can never be 100 times more riskier than the
stock market in general. This is because a small change
in the returns of the stock will make the stock price
go to $0. |
|
