High beta stocks make portfolios riskier but increase the chance of higher returns. Beta is the hedge ratio of an investment with respect to the stock market. For example, https://1investing.in/ to hedge out the market-risk of a stock with a market beta of 2.0, an investor would short $2,000 in the stock market for every $1,000 invested in the stock.
For example, a formerly low beta company can overextend itself by borrowing heavily to fund expansion, or it might acquire a firm in a new sector to gain a foothold. Beta is a useful number to look at when you want to see whether a stock is likely to move up or down with the market or move in the opposite direction of the market. Not surpsingly, there are exchange-traded funds that concentrate on low-beta choices. For example, as of Oct. 27, 2020, the beta for Microsoft (MSFT), as found on Yahoo! Finance, is 0.92. Whether or not a stock has a “good†beta value depends on what you are looking for in a stock.
- Investors use a stock’s beta to estimate how much risk the stock might potentially add or subtract from a diversified portfolio.
- This statistic measures if the investment is more or less volatile compared to the market index it is being measured against.
- High beta stocks make portfolios riskier but increase the chance of higher returns.
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Companies in certain industries tend to achieve a higher β than companies in other industries. Investment professionals use this expected return, in conjunction with other valuation methods, as a basis for investment decisions. Some types of stocks, like those in cyclical industries, have higher betas.
Interpreting Beta
When markets are in turmoil, investors (at least in theory) turn to gold. Investors can also evaluate market volatility through the Volatility Index or VIX, which the Chicago Board Options Exchange created to gauge the 30-day expected volatility of the U.S. stock market. A beta of more than one indicates that the investment is more volatile than the market, while a beta less than one indicates the investment is less volatile than the market. Negative betas are possible and indicate that the investment moves in an opposite direction than the particular market measure. ‘Unlevering’ a beta removes the financial effects of leverage thus isolating the risk due solely to company assets. In other words, how much did the company’s equity contribute to its risk profile.
If the unlevered beta is positive, investors will invest in the company’s stock when prices are expected to rise. A negative unlevered beta will prompt investors to invest in the stock when prices are expected to decline. Beta is the result of a calculation that measures the relative volatility of a stock in correlation to a particular standard. Beta is a form of regression analysis and it can be useful for investors regardless of their risk tolerance.
An index that represents all of the market is a CAPM assumption, but in reality $m$ is typically some stock index (like the S&P 500, which represent U.S. large cap stocks). It’s not practical to build an index that would include all possible aset classes (stocks, bonds, FX, real estate…). Our first stock is WD-40 Company, a chemicals manufacturer that focuses on maintenance products, homecare, and cleaning products globally. WD-40 sells its namesake product in various forms, but also has diversified into other product lines away from its core WD-40 line.
Negative Beta Stocks and Industries
Negative beta is an unusual concept, as it pertains to the stock market. 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. This indicates that adding the stock to a portfolio will increase the portfolio’s risk, but may also increase its expected return.
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A negative beta correlation would mean an investment that moves in the opposite direction from the stock market. This article will discuss how to calculate beta, the difference between high-beta and low-beta stocks, as well as individual analysis of the 3 stocks in the S&P 500 Index with negative beta values. The beta coefficient theory assumes that stock returns are normally distributed from a statistical perspective.
How Stocks Behave During Hyperinflation
The benchmark should be relevant to the stock, and the Treasury maturity should vary based on the investor’s proposed timeline. Risk is an unavoidable part of investing, but it’s also the driver of your returns. Investors look for ways to understand risk, mitigate it and measure it. A beta of 1.5 implies that for every 1% change in the value of the benchmark index, the portfolio’s value tends to change by 1.5%. These estimators attempt to uncover the instant prevailing market-beta. When long-term market-betas are required, further regression toward the mean over long horizons should be considered.
However, the resulting beta would no longer be a market-beta in the typical meaning of the term. In practice, the choice of index makes relatively little difference in the market betas of individual assets, because broad value-weighted market indexes tend to move closely together. Let’s say the beta value of the entire stock market, as measured by an index, is 1.
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. The expected return of the market (or benchmark) is placed into the parentheses with the market risk premium, which is also from the Beta formula. The volatility of a security or portfolio against a benchmark – is called Beta. In short, Beta is measured via a formula that calculates the price risk of a security or portfolio against a benchmark, which is typically the broader market as measured by the S&P 500 Index.
Inverse beta decay, commonly abbreviated to IBD, is a nuclear reaction involving an electron antineutrino scattering off a proton, creating a positron and a neutron. Beta particles have a mass which is half of one thousandth of the mass of a proton and carry either a single negative (electron) or positive (positron) charge. As they have a small mass and can be released with high energy, they can reach relativistic speeds (close to the speed of light).
High Beta Stocks Versus Low Beta
Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. Thus, cash flows that have already occurred will not be part of the computation – they are not incremental.
That is, if a portfolio consists of 80% asset A and 20% asset B, then the beta of the portfolio is 80% times the beta of asset A and 20% times the beta of asset B. Assume that the beta of an investor’s portfolio is 2.0 in relation to a broad market index, such as the S&P 500. If the market increases by 2%, then the portfolio will generally increase by 4%. If the market decreases by 2%, the portfolio generally decreases by 4%. Others concentrate on stocks in sectors that intrinsically have low betas, such as Utilities Select Sector SPDR Fund and Global X NASDAQ 100 Covered Call ETF.. Many brokerage firms calculate the betas of securities they trade and then publish their calculations in a beta book.
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