A stock's 'Beta' is a measure of its volatility derived from the capital asset pricing model. Understanding the Beta Definition The term beta in finance, sometimes written using the Greek letter beta (β), is a measure of volatility in a particular stock or other investment opportunity.
What would be considered a high beta on a stock?
- Microsoft has a beta of around 1.25. This means an investor can reasonably expect that this stock is 25% more volatile than the market. ...
- Walt Disney Company has a beta right around 1.03. This puts its volatility right in line with the broader market. ...
- In contrast, Duke Energy has a beta of around 0.27. ...
What factors determine the beta of a stock?
Beta is determined by the cyclicality of a firm's revenues. This cyclicality is magnified by the firm's operating and financial leverage. (1) Revenues. The cyclicality of a firm's sales is an important factor in determining beta. In general, stock prices will rise when the economy expands and will fall when the economy contracts.
How to easily calculate the beta of a stock?
Top 3 Formula to Calculate Beta
- Covariance/Variance Method. To calculate the covariance Calculate The Covariance Covariance is a statistical measure used to find the relationship between two assets and is calculated as the standard deviation ...
- By Slope Method in Excel. We can also calculate Beta by using the slope function in excel. ...
- Correlation Method. ...
How do you calculate beta of stock?
Stock Beta formula. Stock’s Beta is calculated as the division of covariance of the stock’s returns and the benchmark’s returns by the variance of the benchmark’s returns over a predefined period. Below is the formula to calculate stock Beta. Stock Beta Formula = COV(Rs,RM) / VAR(Rm)
What is a good beta for a stock?
What Is a Good Beta Value for a Stock? Whether or not a stock has a “good” beta value depends on what you are looking for in a stock. If you're risk averse, then look for a stock with a beta value at or below 1.0. If you're looking for something more exciting, then consider a stock with a value of above 2.0.
What does a stock 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 beta of 0.5 mean?
If a stock had a beta of 0.5, we would expect it to be half as volatile as the market: A market return of 10% would mean a 5% gain for the company. Here is a basic guide to beta levels: Negative beta: A beta less than 0, which would indicate an inverse relation to the market, is possible but highly unlikely.
Do you want beta to be high or low?
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 beta of 1.20 indicate?
Trading-Glossary. "A measure of a fund's risk, or volatility, compared to the market which is represented as 1.0. A fund with a beta of 1.20 is 20% more volatile than the market, while a fund with a beta of 0.80 would be 20% less volatile than the market."
What is a good PE ratio?
So, what is a good PE ratio for a stock? A “good” P/E ratio isn't necessarily a high ratio or a low ratio on its own. The market average P/E ratio currently ranges from 20-25, so a higher PE above that could be considered bad, while a lower PE ratio could be considered better.
Is a low beta good?
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.
Can beta of a stock be negative?
Here is the answer. Yes, beta can be negative. To see how and why, consider what beta measures: the risk added by an investment to a well diversified portfolio. By that definition, any investment that when added to a portfolio, makes the overall risk of the portfolio go down, has a negative beta.
Can a stock have a zero beta?
A zero-beta portfolio is constructed to have zero systematic risk—a beta of zero. Beta measures an investment's sensitivity to a price movement of a specifically referenced market index.
Is it good to invest in high beta stocks?
High beta stocks can be great investments in bull markets since they are expected to outperform the S&P 500 by a marginal amount. They do however require a great deal of active management due to their market sensitivity. These are highly volatile and therefore risky investments in isolation.
Are high beta stocks good?
High beta stocks have historically outperformed the market, which is why they hold great significance for investors. While beta values have been historically used to calculate stocks' volatility, it is not wise to depend entirely on the beta alone to measure the potential of a company.
What stock has the highest beta?
Here's a look at the eight S&P 500 stocks with the highest betas, according to Finviz.Advanced Micro Devices, Inc. ... United Rentals, Inc. ... Freeport-McMoRan Inc (NYSE: FCX), 2.51 beta.Devon Energy Corp (NYSE: DVN), 2.38 beta.Marathon Oil Corporation (NYSE: MRO), 2.31 beta.SVB Financial Group (NASDAQ: SIVB), 2.19 beta.More items...
Does a higher beta mean more risk?
Yes. A higher beta indicates higher volatility and hence a higher risk relative to the market.
Does a higher beta mean more reward?
It means a higher potential reward for a given move in the market, yes.
Does Beta only capture downside price volatility?
No. Beta captures relative volatility, which considers both directions.
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 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 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.
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 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 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 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 ...
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 ...
What is beta in stock?
Beta can be a useful metric to determine how a stock’s price may move in relation to the overall market by examining its past performance. It can also be a useful indicator of risk, especially for investors who make trades frequently. However, beta has its limitations.
What does beta mean in stock market?
Beta is represented as a number. Based on beta analysis, the overall stock markethas a beta of 1. And the beta of individual stocks determines how far they deviate from the broader market. A stock with a beta equal to 1 assumes its price moves hand-in-hand with the market.
What does it mean when a stock has a beta of 1?
If the stock has a beta less than 1, you can conclude that it’s less volatile than the overall market. This means that adding it to your portfolio may mitigate risk and may help in diversifying your investments. Betas can also dip below 1 into negative territory. This indicates that the stock may respond in the opposite direction ...
Why is beta high?
A stock with a high beta indicates it’s more volatile than the overall market and can react with dramatic share-price changes amid market swings. So if you don’t have the stomach for vast price changes, you may want to avoid investing in high-beta stocks.
What is beta in investing?
Nonetheless, beta can be one of many useful tools to have when evaluating your investments. So it’s important to at least calculate the beta of a stock you may be interested in purchasing. Before You Calculate Beta. Remember, beta measures how volatile a stock’s price may be in relation to a market benchmark. ...
What does it mean to have a high beta?
In essence, it would have a high beta and mean more risk.
Is beta a factor?
But beta is just one factor to consider when examining investments. This article will help you understand what it means and how you can use it to build a better portfolio that matches your risk tolerance. A financial advisorcan also help you take advantage of beta to make better investment decisions.
What is beta in stock market?
Definition: Beta is a numeric value that measures the fluctuations of a stock to changes in the overall stock market. Description: Beta measures the responsiveness of a stock's price to changes in the overall stock market.
What does a positive beta mean in stocks?
A positive beta value indicates that stocks generally move in the same direction with that of the market and the vice versa. Also see: volatility, CAPM, NSE Nifty, alpha. PREV DEFINITION.
What does 1.3 mean in stock?
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 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 the market. It's hard not to think that stock wil…
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