Stock Beta
A measure of risk - or volatility?

Stock beta is a measure of the price volatility of a stock compared to the rest of the market. It answers the question: how does the stock’s price move relative to the overall market?

Beta beta calculation is performed using regression analysis. The whole market is assigned a beta of 1.

Stocks that have a beta greater than 1 have greater price volatility than the overall market and are considered to have greater risk.

Stocks with a beta of 1 move up and down with the market. Stocks with a beta of less than 1 have less price volatility than the market and are considered to have less risk.

Risk relates to return. Investors normally expect that stocks with a higher beta should command a risk premium, that is provide a higher return than the market.

For example, if the market with a beta of 1 is expected to return 8%, a stock with a beta of 1.5 should return 12%. If you don’t see that level of return, then the stock is not a good investment possibility.

Stocks with a beta below 1 should be a safer investment, assuming you define risk as volatility. So you should expect a lower return.

A stock’s beta can also be compared to the average beta for its sector to get a picture of whether the stock is out of line with its industry.

My online broker provides a beta value for each stock, and for its sector.

Factors to take into account about the use of beta as a measure of risk include ...

• beta is bsed on historical data that is not always an accurate predictor of the future volatility of the stock
• beta does not take into account any new initiatives being undertaken by a company such as acquisitions that may alter the price volatility of the stock
• whether beta as a measure volatility has any credible relationship with risk for your investment time horizon
• the best use of the beta ratio may be in short-term buying and selling, where price volatility is important

For long-term value investors, the beta has little relevance. Value investors are more concerned with a company’s fundamentals.

This particularly relates to estimating its intrinsic value to provide an approximate means of assessing the risk of buying the stock at a particular price level.

Value investors reject the idea of beta because it implies that a stock that has fallen sharply in value is more risky than it was before it fell. A value investor would argue that a company represents a lower-risk investment after it falls in value.

For the value investor, buying a stock below its intrinsic value would imply less risk and buying it at a price above the intrinsic value would imply greater risk.

So beta is more relevant to short-term risk which is not a concern for value investors.

Return from Stock Beta to Investment Risk