Beta is a useful statistical tool to measure the volatility of stocks. Despite some limitations, it continues to enjoy popularity among stock market analysts.
Investors consider a number of parameters such as EPS, P/E ratios in order to arrive at a good buy. However, there exist other markers that can give you an indication of how risky a stock might eventually turn out to be.
One such marker is the stock’s Beta component, a useful and easy way of calculating the volatility degree of a stock.

What is Beta?

Beta (β or beta coefficient) measures a stock’s exposure to both systematic and unsystematic risks arising from market dynamics. It assigns a numeric value, one that serves to throw light on stock price fluctuations relative to changes in the market.

What are unsystematic risks?

This comprises risks stemming from company-related matters including delay in completion of big-ticket projects, doubts over growth potential of the company, both internal and external competition, shifts in overall industry structure and financing patterns of the company.

What are systematic risks?

In this case, fluctuations in stock prices rest on continual market rearrangements. Besides being affected by events such as RBI policies or a newly-introduced budget, the stock market undergoes other fluctuations over time. These changes are collectively called ‘market sentiments’, something that either propel stock prices forward or effect a nosedive.

Share price alternations can be a three-way movement; some move in tandem with the overall market, few fluctuate more (vis-à-vis the market) on the same side of it, whereas some might undulate inversely.

Calculation and analysis of Beta

While many parameters abound, calculating Beta is probably the easiest way to measure a stock’s risk profile, volatility and the degree of relative association with the overall market. Analysis of Beta can generate valuable insights into the why’s of stock price fluctuations.

Referred to as financial elasticity, Beta is a count of individual stock risks in relation to overall volatility that is prevalent in the market. So much so, that a sound Beta analysis is often at the bed of improved portfolio performance over time.

The formula has been stated below:
Beta = Covariance (stock v/s market returns) / Variance of the overall stock market

Interpretation of Beta

Beta value (β)
Usual interpretations

β > 1

 
Stock returns fluctuate more in proportion to market returns while moving in the same direction

β = 1

 
Stock returns are exactly proportional to market returns, while moving in the same direction

0 < β < 1

 
Both stock and market returns move in the same direction but the former moves less in proportion to the latter

β = 0

 
Stock fluctuations bear no correlation with overall market fluctuations

β < 0

 
Stock returns are moving in the opposite direction compared to market returns

In conclusion

The way you deploy Beta while investing in stocks rests on your stomach for risks. Should you choose stocks with Beta component more than 1, get ready and brace yourself for volatilities. However, while investments in these stocks may put you on a bumpy ride, it might (in all probability) amount to an increased likelihood of cashing in on superior returns. A Beta component > 1 is for the seasoned aggressive investor’s taking.

Conversely, a conservative investor should ideally look for stocks that attach a Beta component that is equal to 1 or less than 1 (0 < Beta < 1). With this figure, chances are fluctuations in the stock would be less compared to overall market shifts. That being said, such stocks are likely to spawn lower returns as compared to their high-Beta counterparts.

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DISCLAIMER

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.



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