If you are investing based on a stock's fundamentals, beta has plenty of shortcomings. For starters, beta doesn't incorporate new information. Consider a utility company: let's call it Company X. Company X has been considered a defensive stock with a low beta.
When it entered the merchant energy business and assumed more debt, X's historic beta no longer captured the substantial risks the company took on. At the same time, many technology stocks are relatively new to the market and thus have insufficient price history to establish a reliable beta. Another troubling factor is that past price movement is a poor predictor of the future.
Betas are merely rear-view mirrors, reflecting very little of what lies ahead. Furthermore, the beta measure on a single stock tends to flip around over time, which makes it unreliable. Granted, for traders looking to buy and sell stocks within short time periods, beta is a fairly good risk metric. However, for investors with long-term horizons, it's less useful.
The well-worn definition of risk is the possibility of suffering a loss. Of course, when investors consider risk, they are thinking about the chance that the stock they buy will decrease in value.
The trouble is that beta, as a proxy for risk, doesn't distinguish between upside and downside price movements. For most investors, downside movements are a risk, while upside ones mean opportunity. Beta doesn't help investors tell the difference. For most investors, that doesn't make much sense. There is an interesting quote from Warren Buffett regarding the academic community and its attitude towards value investing : "Well, it may be all right in practice, but it will never work in theory.
Value investors scorn the idea of beta because it implies that a stock that has fallen sharply in value is riskier than it was before it fell. A value investor would argue that a company represents a lower-risk investment after it falls in value—investors can get the same stock at a lower price despite the rise in the stock's beta following its decline.
Beta says nothing about the price paid for the stock in relation to fundamental factors like changes in company leadership, new product discoveries, or future cash flows. A stock's beta will change over time because it compares the stock's return with the returns of the overall market.
Benjamin Graham, the "father of value investing," and his modern advocates tried to spot well-run companies with a "margin of safety"—that is, an ability to withstand unpleasant surprises. Some elements of safety come from the balance sheet , like having a low ratio of debt-to-total capital. Some come from the consistency of growth, in earnings, or dividends.
An important one comes from not overpaying. For example, stocks trading at low multiples of their earnings are viewed as safer than stocks at high multiples, although this is not always the case.
Ultimately, it's important for investors to make the distinction between short-term risk—where beta and price volatility are useful—and longer-term, fundamental risk, where big-picture risk factors are more telling.
High betas may mean price volatility over the near term, but they don't always rule out long-term opportunities. Berkshire Hathaway. Financial Ratios. Investing Essentials. Tools for Fundamental Analysis. Technical Analysis Basic Education. Your Privacy Rights. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. Beta is a measure of the volatility — or systematic risk — of a security or portfolio compared to the market as a whole.
Beta is used in the capital asset pricing model CAPM , which describes the relationship between systematic risk and expected return for assets usually stocks. CAPM is widely used as a method for pricing risky securities and for generating estimates of the expected returns of assets, considering both the risk of those assets and the cost of capital. A beta coefficient can measure the volatility of an individual stock compared to the systematic risk of the entire market.
In statistical terms, beta represents the slope of the line through a regression of data points. In finance, each of these data points represents an individual stock's returns against those of the market as a whole. Beta effectively describes the activity of a security's returns as it responds to swings in the market.
A security's beta is calculated by dividing the product of the covariance of the security's returns and the market's returns by the variance of the market's returns over a specified period. The calculation for beta is as follows:. The beta calculation is used to help investors understand whether a stock moves in the same direction as the rest of the market.
It also provides insights about how volatile—or how risky—a stock is relative to the rest of the market. For beta to provide any useful insight, the market that is used as a benchmark should be related to the stock. Ultimately, an investor is using beta to try to gauge how much risk a stock is adding to a portfolio. In order to make sure that a specific stock is being compared to the right benchmark, it should have a high R-squared value in relation to the benchmark.
R-squared is a statistical measure that shows the percentage of a security's historical price movements that can be explained by movements in the benchmark index. When using beta to determine the degree of systematic risk, a security with a high R-squared value, in relation to its benchmark, could indicate a more relevant benchmark.
One way for a stock investor to think about risk is to split it into two categories. The first category is called systematic risk, which is the risk of the entire market declining.
The financial crisis in is an example of a systematic-risk event; no amount of diversification could have prevented investors from losing value in their stock portfolios. Systematic risk is also known as un-diversifiable risk.
Unsystematic risk , also known as diversifiable risk, is the uncertainty associated with an individual stock or industry. For example, the surprise announcement that the company Lumber Liquidators LL had been selling hardwood flooring with dangerous levels of formaldehyde in is an example of unsystematic risk. Unsystematic risk can be partially mitigated through diversification.
If a stock has a beta of 1. A stock with a beta of 1. Adding a stock to a portfolio with a beta of 1. A beta value that is less than 1. Including this stock in a portfolio makes it less risky than the same portfolio without the stock. For example, utility stocks often have low betas because they tend to move more slowly than market averages.
A beta that is greater than 1. For example, if a stock's beta is 1. Technology stocks and small cap stocks tend to have higher betas than the market benchmark. Username Please enter your Username. Password Please enter your Password. Forgot password? Don't have an account? Sign in via your Institution. You could not be signed in, please check and try again. Sign in with your library card Please enter your library card number. Related Content Related Overviews capital asset pricing model alpha coefficient multiple regression variance See all related overviews in Oxford Reference ».
Show Summary Details Overview beta coefficient. All rights reserved.
0コメント