The beta in finance is a financial metric that measures how sensitive is the stock price concerning the change in the market price (index). The Beta is used for measuring the systematic risks associated with the specific investment.
What is the beta of the market?
It's generally used as both a measure of systematic risk and a performance measure. The market is described as having a beta of 1. The beta for a stock describes how much the stock's price moves compared to the market.
Do stocks with a positive beta have a higher beta?
Stocks generally have a positive beta since they are correlated to the market. Beta is a statistical measure of the volatility of a stock versus the overall market. A beta above 1 means a stock is more volatile than the overall market. A beta below 1 means a stock is less volatile than the overall market.
Why does a stock's beta change over time?
A stock's beta will change over time because it compares the stock's return with the returns of the overall market.
What are the disadvantages of beta in stock market?
The Disadvantages of Beta. Another troubling factor is that past price movements are very poor predictors 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.
Is beta sensitivity to the market?
The beta of a stock or portfolio will tell you how sensitive your holdings are to systematic risk, where the broad market itself always has a beta of 1.0. High betas indicate greater sensitivity to systematic risk, which can lead to more volatile price swings in your portfolio, but which can be hedged somewhat.
Does beta affect stock price?
Key Takeaways Beta indicates how volatile a stock's price is in comparison to the overall stock market. A beta greater than 1 indicates a stock's price swings more wildly (i.e., more volatile) than the overall market. A beta of less than 1 indicates that a stock's price is less volatile than the overall market.
Does higher beta mean higher price?
A beta that is greater than 1.0 indicates that the security's price is theoretically more volatile than the market. For example, if a stock's beta is 1.2, it is assumed to be 20% more volatile than the market. Technology stocks and small cap stocks tend to have higher betas than the market benchmark.
Do you want a stock with a high or low beta?
A stock that swings more than the market over time has a beta above 1.0. If a stock moves less than the market, the stock's beta is less than 1.0. High-beta stocks are supposed to be riskier but provide higher return potential; low-beta stocks pose less risk but also lower returns.
What does a stock's beta tell you?
Beta is a way of measuring a stock's volatility compared with the overall market's volatility. The market as a whole has a beta of 1. Stocks with a value greater than 1 are more volatile than the market (meaning they will generally go up more than the market goes up, and go down more than the market goes down).
What affects beta of a stock?
The more the debt, the greater is the risk of the business organization. So, growth in financial leverage increases the financial risk. Therefore, this will increase the beta of a companies' stock as well.
How do you read a stock beta?
A β of 1 indicates that the price of a security moves with the market. A β of less than 1 indicates that the security is less volatile than the market as a whole. Similarly, a β of more than 1 indicates that the security is more volatile than the market as a whole.
What does a beta of 1.5 mean?
Roughly speaking, a security with a beta of 1.5, will have move, on average, 1.5 times the market return. [More precisely, that stock's excess return (over and above a short-term money market rate) is expected to move 1.5 times the market excess return).]
Why do most stocks have a positive beta?
If a stock has a beta above 1, it's more volatile than the overall market. For example, if an asset has a beta of 1.3, it's theoretically 30% more volatile than the market. Stocks generally have a positive beta since they are correlated to the market.
Is a high beta stock good?
High beta stocks are those that are positively correlated with returns of the S&P 500, but at an amplified magnitude. Because of this amplification, these stocks tend to outperform in bull markets, but can greatly underperform in bear markets.
Is a lower beta good?
High And Low Beta Value A low beta value typically means that the stock is considered less risky, but will likely offer low returns as well. The higher the beta value, the more risk you take as an investor, but the higher your chances are of a big return as well.
What does a beta of 0.6 mean?
Teva Pharmaceutical Industry's 2.49 beta, for example, indicates that the stock is expected to be more than twice as volatile than the market, while Intel's beta of 0.6 means the stock will typically move at a rate that's only about half that the broader market (data from Yahoo Finance, June 13, 2019).
What does a beta of 1.5 mean?
Roughly speaking, a security with a beta of 1.5, will have move, on average, 1.5 times the market return. [More precisely, that stock's excess return (over and above a short-term money market rate) is expected to move 1.5 times the market excess return).]
What does a β of 1.3 mean?
For example, if a stock's beta value is 1.3, it means, theoretically this stock is 30% more volatile than the market. Beta calculation is done by regression analysis which shows security's response with that of the market.
What does a beta of 0.6 mean?
Teva Pharmaceutical Industry's 2.49 beta, for example, indicates that the stock is expected to be more than twice as volatile than the market, while Intel's beta of 0.6 means the stock will typically move at a rate that's only about half that the broader market (data from Yahoo Finance, June 13, 2019).
What is a good beta for a portfolio?
For example, a portfolio with an overall beta of +0.7 would be expected to earn 70% of the market's return under normal circumstances. Portfolios, however, can also have betas greater than 1.0, such that a portfolio with a beta of +1.25 would be expected to earn 125% of the market's return and so on.
What does beta mean in investing?
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.
What is beta in stocks?
What Is Beta? Beta is a measure of a stock's volatility in relation to the overall market. By definition, the market, such as the S&P 500 Index, has a beta of 1.0, and individual stocks are ranked according to how much they deviate from the market.
What is beta in CAPM?
Beta is a component of the capital asset pricing model (CAPM), which is used to calculate the cost of equity funding. The CAPM formula uses the total average market return and the beta value of the stock to determine the rate of return that shareholders might reasonably expect based on perceived investment risk.
Why is beta important?
To followers of CAPM, beta is useful. A stock's price variability is important to consider when assessing risk. If you think about risk as the possibility of a stock losing its value, beta has appeal as a proxy for risk. Intuitively, it makes plenty of sense.
Why does beta change over time?
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.
Why do analysts use beta?
Analysts use it often when they want to determine a stock's risk profile. However, while beta does say something about price risk, it has its limits for investors looking to determine fundamental risk factors.
What does value investor mean?
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.
Why is the beta of a stock below 1?
If the beta is below 1, the stock either has lower volatility than the market, or it's a volatile asset whose price movements are not highly correlated with the overall market. The price of Treasury bills (T-bills) has a beta lower than 1 because T-bills don't move in relation to the overall market. Many consider stocks in the utility sector ...
What does beta mean in stock?
Beta is a statistical measure of the volatility of a stock versus the overall market. A beta above 1 means a stock is more volatile than the overall market. A beta below 1 means a stock is less volatile than the overall market. The S&P 500, Dow Jones Industrial Average, and Nasdaq 100 are frequently used beta measures.
What does it mean when a stock has a beta of 1?
If a stock has a beta above 1, it's more volatile than the overall market. For example, if an asset has a beta of 1.3, it's theoretically 30% more volatile than the market. Stocks generally have a positive beta since they are correlated to the market.
How to find out if a stock has a beta of 2?
To begin, select the "Technical" tab within the "Filters" section. Under the "Beta" tab, select " Over 2" from the dropdown menu. This displays a list of stocks that have a beta higher than 2. Traders can add additional filters, such as country, exchange, and index.
What is beta in hedge funds?
Beta is an important concept for the analysis of hedge funds. It can show the relationship between a hedge fund’s returns and the market return. Beta can show how much risk the fund is taking in certain asset classes and can be used to measure against other benchmarks, such as fixed income or even hedge fund indexes.
How to calculate beta?
The beta coefficient is calculated by dividing the covariance of the stock return versus the market return by the variance of the market. Beta is used in the calculation of the capital asset pricing model (CAPM). This model calculates the required return for an asset versus its risk. The required return is calculated by taking the risk-free rate plus the risk premium. The risk premium is found by taking the market return minus the risk-free rate and multiplying it by the beta.
What is the most commonly used stock index?
The most commonly used stock index is the S&P 500. The S&P 500 is used as the measure because of the high number of large-cap stocks included in the index and the broad number of sectors included. The Dow Jones Industrial Average (DJIA) has also previously been the main measure of the market, but it has fallen out of favor since it only includes 30 ...
What does a beta of 1 mean?
Beta of 1 implies that the volatility of the stock is exactly the same as that of the underlying market or the index in both qualitative and quantitative terms. Beta of greater than 1 implies that the stock is more volatile than the underlying market or index. A negative Beta is possible but highly unlikely.
What does it mean when the beta of a stock is negative?
The Stock Beta can have three types of values: Beta < 0: If the Beta is negative, then this implies an inverse relationship between the stock and the underlying market or the benchmark in comparison. Both stock and the market or the benchmark will move in the opposite direction. Beta = 0: If the Beta is equal to zero, ...
What is beta in stock market?
Stock Beta is one of the statistical tools that quantify the volatility in the prices of a security or stock with reference to the market as a whole or any other benchmark used for comparing the performance of the security. It is actually a component of Capital Asset Pricing Model (CAPM)
What does it mean when the beta is greater than zero?
Beta > 0: If the Beta is greater than zero, then there is a strong direct relationship between the stock and the underlying market or the benchmark. Both stock and the market or the benchmark will move in the same direction. Some further insight is as follows:
What does it mean when the beta is 0?
Beta = 0: If the Beta is equal to zero, then this implies that there is no relation between the movement of the returns of the stock and the market or the benchmark, and hence both are too dissimilar to have any common pattern in price movements . Beta > 0: If the Beta is greater than zero, then there is a strong direct relationship between ...
What is a statistical tool?
It is one single statistical tool that investors frequently use to assess the risk that the stock may add to their portfolio, allowing them to gauge the risk in both qualitative and quantitative terms and to assess the risk and rewards associated with the stock.
Is a negative beta of gold a good thing?
A negative Beta is possible but highly unlikely. Most investors believe that gold and stock based on gold tend to perform better when the market dives. Whereas a Beta of zero is possible in the case of government bonds acting as risk-free securities providing a low yield to the investors.
What is asset beta?
Unlevered Beta / Asset Beta Unlevered Beta (Asset Beta) is the volatility of returns for a business, without considering its financial leverage. It only takes into account its assets. , on the other hand, only shows the risk of an unlevered company relative to the market.
Why is equity beta called equity beta?
It is also commonly referred to as “equity beta” because it is the volatility of an equity based on its capital structure. Capital Structure Capital structure refers to the amount of debt and/or equity employed by a firm to fund its operations and finance its assets. A firm's capital structure.
What is leveraged beta?
Levered beta, also known as equity beta or stock beta, is the volatility of returns for a stock, taking into account the impact of the company’s leverage from its capital structure. It compares the volatility (risk) of a levered company to the risk of the market. Levered beta includes both business risk. Systemic Risk Systemic risk can be defined ...
Is a company with a 0f 0.79 more volatile than the market?
Also, a company with a β of 1.30 is theoretically 30% more volatile than the market. Similarly, a company with a β 0f 0.79 is theoretically 21% less volatile than the market.
What is a beta of 1.0?
A stock with a beta of 1.0 has systematic risk. However, the beta calculation can’t detect any unsystematic risk. Adding a stock to a portfolio with a beta of 1.0 doesn’t add any risk to the portfolio, but it also doesn’t increase the likelihood that the portfolio will provide an excess return.
What is beta in stocks?
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 ...
Why is beta important?
Beta is useful in determining a security's short-term risk, and for analyzing volatility to arrive at equity costs when using the CAPM. However, since beta is calculated using historical data points, it becomes less meaningful for investors looking to predict a stock's future movements.
How does beta work?
How Beta Works. 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.
What does it mean when a stock has a beta of less than 1.0?
Beta Value Less Than One. A beta value that is less than 1.0 means that the security is theoretically less volatile than the market. Including this stock in a portfolio makes it less risky than the same portfolio without the stock.
What is beta in capital asset pricing?
Beta, primarily used in the capital asset pricing model (CAPM), is a measure of the volatility–or systematic risk–of a security or portfolio compared to the market as a whole.
What is CAPM in financials?
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.
What does a beta of 1 mean?
A beta of 1 indicates that the portfolio will move in the same direction, have the same volatility and is sensitive to systematic risk. Note that the S&P 500 index is often used as the benchmark for the broader stock market and the index has a beta of 1.0.
What is beta risk?
Beta and Systematic Risk. Beta is a measure of a stock's volatility in relation to the market. It essentially measures the relative risk exposure of holding a particular stock or sector in relation to the market. If you want to know the systematic risk of your portfolio, you can calculate its beta. Beta effectively describes the activity ...
Why is systematic risk difficult to predict?
Systematic risk affects the overall market and is therefore difficult to predict and hedge against. Unlike with unsystematic risk, diversification cannot help to smooth systematic risk, because it affects a wide range of assets and securities. For example, the Great Recession was a form of systematic risk; the economic downturn affected ...
What does a negative beta mean?
A negative beta (i.e., less than 0) indicates that it moves in the opposite direction of the market and that there is a negative correlation with the market. A beta between 0 and 1 signifies that it moves in the same direction as the market, but with less volatility—that is, smaller percentage changes—than the market as a whole. ...
Can systematic risk be eliminated?
Systematic risk cannot be eliminated through diversification since it is a nonspecific risk that affects the entire market. The beta of a stock or portfolio will tell you how sensitive your holdings are to systematic risk, where the broad market itself always has a beta of 1.0.
Why is beta used in CAPM?
while conducting valuations. The CAPM uses beta to calculate the systematic risk of the market. In general, this can be used to value a lot of companies with various capital structures. Volatility: Beta is a single measure which helps the investors to understand stock volatility in comparison to the market.
How is beta calculated?
Beta is calculated based on the stock prices in comparison to the market prices. Therefore for startups or private companies, it is difficult to calculate beta. There are methods like unleveraged beta and leveraged betas, but that also requires a lot of assumptions to be made.
What does it mean when the beta of a stock is equal to one?
Beta in Finance Interpretation. If Beta = 1: If the Beta of the stock was equal to one, this means that the stock has the same level of risk as to the stock market. If the market rises by 1%, the stock will also rise by 1%, and if the market comes down by 1%, the stock will also come down by 1%. If Beta > 1: If the Beta ...
What is beta in finance?
The beta in finance is a financial metric that measures how sensitive is the stock price with respect to the change in the market price ( index). The Beta is used for measuring the systematic risks associated with the specific investment. In statistics, beta is the slope of the line, which is obtained by regressing the returns ...
What is the difference between Amazon and S&P 500?
Amazon has a standard deviation of returns of 23.42% while S&P 500 has a standard deviation of 32.21%. Beta = 0.83 x (23.42% divided by 32.21%)= 0.60. The beta for the market is 1, while for Amazon is 0.60.
How does beta help?
Beta can help to assess systematic risk#N#Assess Systematic Risk Systematic Risk is defined as the risk that is inherent to the entire market or the whole market segment as it affects the economy as a whole and cannot be diversified away and thus is also known as an “undiversifiable risk” or “market risk” or even “volatility risk”. read more#N#. However, it does not guarantee future returns. Beta can be calculated at various frequencies, including two months, six months, five years, etc. Using the past data cannot hold true for the future. It makes it difficult for the user to predict the stock’s future movements.
How to calculate weekly returns?
Step 1: Get the weekly/mont hly/quarterly prices of the stock. Step 2: Get the weekly/monthly/quarterly prices of the index. Step 3: Calculate the weekly/monthly/quarterly returns of the stock. Step 4: Calculate the weekly/monthly/quarterly returns of the market.
What is the benefit of using beta coefficient?
Advantages of using Beta Coefficient. One of the most popular uses of Beta is to estimate the cost of equity (Re) in valuation models. The CAPM estimates an asset’s Beta based on a single factor, which is the systematic risk of the market.
What is systematic risk?
Systematic Risk Systematic risk is that part of the total risk that is caused by factors beyond the control of a specific company or individual. Systematic risk is caused by factors that are external to the organization. All investments or securities are subject to systematic risk and therefore, it is a non-diversifiable risk.
What is beta coefficient?
The Beta coefficient is a measure of sensitivity or correlation of a security. Marketable Securities Marketable securities are unrestricted short-term financial instruments that are issued either for equity securities or for debt securities of a publicly listed company. The issuing company creates these instruments for the express purpose ...
What are the drawbacks of beta?
The largest drawback of using Beta is that it relies solely on past returns and does not account for new information that may impact returns in the future. Furthermore, as more return data is gathered over time, the measure of Beta changes, and subsequently, so does the cost of equity.
What is GDP in macroeconomics?
Large changes in macroeconomic variables, such as interest rates, inflation, GDP. GDP Formula Gross Domestic Product (GDP) is the monetary value, in local currency, of all final economic goods and services produced in a country during a. , or foreign exchange, are changes that impact the broader market and that cannot be avoided through ...
What is CAPM in business?
CAPM is a vehicle for quantifying risk and linking it with expected returns on a company’s equity. In this article I describe how one company, Alaska Interstate, Inc., tried to quantify risk and incorporate consideration of it into the company’s strategic planning process.
What is Alaska Interstate?
Alaska Interstate was a diversified company whose stock was listed on the New York Stock Exchange. (In 1982, following a retreat from diversification, the company changed its name to ENSTAR Corporation, but in this article I use the former name and former ticker symbol—AKI—because the events described took place when it was Alaska Interstate.) At the time that management underwent the self-analysis, its holdings consisted of unintegrated businesses, including several oil and gas exploration and production ventures in and outside the United States, a public utility, and an agricultural equipment manufacturer. Strategic planning is particularly difficult in a company with such diverse holdings.
What was the beta of AKI in 1978?
By January 1978, AKI’s beta was about 1.4 and its shareholders had received an average annual rate of return of about 1 % (dividends plus capital gains) over the previous two and a half years, the period for which the beta had been calculated.
Why is Alaska Gas deteriorating?
The group judged Alaska Gas to be in a superior position with respect to its facilities and resources but also in a deteriorating position because of the declining growth rate of its Anchorage market. In addition, Alaska Gas had adopted a firm stand toward its regulator, the Alaska Public Utility Commission.
When did AKI drop beta?
Exhibit I AKI’s Beta April 1973–January 1978. In 1977 the beta dropped after Alaska Interstate announced the formation of VICO, a big gas exploration and development venture in Indonesia. AKI’s managers were surprised because they considered the investment to be risky.
Is AKI riskier than the market?
If its stock prices fluctuated more than those of the market as a whole, then AKI could be considered more susceptible to macroeconomic shifts —or riskier—than the average company. If AKI’s stock price history showed more stability than the market’s, the company could be considered to have below-average risk.
When were betas determined?
First, the analysts determined the betas as of January 1977 for the comparison companies and—according to the degree of leverage, the tax rate, and betas in the stock market—adjusted them for the effects of various levels of financial leverage.
What Is Beta?
Calculating Beta
- Beta is calculated using regression analysis. Numerically, it represents the tendency for a security's returns to respond to swings in the market. The formula for calculating beta is the covariance of the return of an asset with the return of the benchmarkdivided by the variance of the return of the benchmark over a certain period. Beta=CovarianceVariance\text{Beta} = \frac{\text…
The Advantages of Beta
- To followers of CAPM, beta is useful. A stock's price variability is important to consider when assessing risk. If you think about risk as the possibility of a stock losing its value, beta has appeal as a proxy for risk. Intuitively, it makes plenty of sense. Think of an early-stage technology stock with a price that bounces up and down more than t...
The Disadvantages of Beta
- 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 stockwith a low beta. When it entered the merchant energy business and assumed more debt, X's historic beta no longer captured the …
Assessing Risk
- 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 downsideprice movements. For most investors, downside movements are a risk, while upside ones mean oppor…
The Bottom Line
- 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.
Examples of Beta
Calculation
- Below is an Excel β calculator that you can download and use to calculate β on your own. β can easily be calculated in Excel using the Slope function. Follow these steps to calculate β in Excel: 1. Obtain the weekly prices of the stock 2. Obtain the weekly prices of the market index (i.e., S&P 500 Index) 3. Calculate the weekly returns of the stock 4. Calculate the weekly returns of the market i…
What Are Equity Beta and Asset Beta?
- Levered beta, also known as equity beta or stock beta, is the volatility of returns for a stock, taking into account the impact of the company’s leverage from its capital structure. It compares the volatility (risk) of a levered company to the risk of the market. Levered beta includes both business risk and the risk that comes from taking on debt. ...
Levered Beta vs Unlevered Beta
- Levered beta (equity beta) is a measurement that compares the volatility of returns of a company’s stock against those of the broader market. In other words, it is a measure of risk, and it includes the impact of a company’s capital structure and leverage. Equity beta allows investors to assess how sensitive a security might be to macro-market risks. For example, a company with a …
Calculation of Levered Beta
- There are two ways to estimate the levered beta of a stock. The first, and simplest, way is to use the company’s historical β or just select the company’s beta from Bloomberg. The second, and more popular, way is to make a new estimate for β using public company comparables. To use the comparables approach, the β of comparable companies is taken from Bloomberg and the un…
Interpreting Beta
- A security’s β should only be used when its high R-squared value is higher than the benchmark. The R-squared value measures the percentage of variation in the share price of a security that can be explained by movements in the benchmark index. For example, a gold ETF will show a low β and R-squared in relation to a benchmark equity index, as gold is negatively correlated with equit…
Related Readings
- Thank you for reading CFI’s guide to beta (β) of an investment security. To continue learning and advancing your career these additional resources will be helpful: 1. Types of Valuation Multiples 2. Analysis of Financial Statements 3. Leverage Ratios 4. Valuation Methods