What does beta mean: how to assess the risk of a stock

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When investing money, be prepared for obstacles along the way. The stock market goes up and down all the time, but the individual stocks that make up the market all move at different rates. Some may have higher highs and lower lows, and others may move almost identically to the market as a whole. Will a stock look like a roller coaster ride? Or will you rather feel like you’re driving on a freeway at the same pace as the car next to you? Its beta version may offer some useful clues.

What is beta and how does it work?

Beta is a way to measure the volatility of a stock relative to the overall volatility of the market. The market as a whole has a beta of 1. Stocks with a value greater than 1 are more volatile than the market, and stocks with a beta less than 1 have a smoother course.

Using beta to assess the risk of a stock

Beta works as a good benchmark against a larger index fund, but it doesn’t provide a full picture of a stock’s risk. Instead, it’s a look at its level of volatility, and it’s important to note that volatility can be good or bad. Investors are not complaining about upward price movements. The downward movement in prices, of course, will keep people awake at night.

Consider comparing the beta of different stocks the same way you might compare nutrition labels at the grocery store. If you’re a more risk averse investor who is focused on generating income, you might avoid high beta stocks in the same way someone with dietary restrictions might avoid buying certain foods. A younger, more aggressive investor with a higher risk tolerance might be more inclined to hunt high beta stocks in the same way that an adventurous cook will seek out foods with exotic ingredients.

Beta is a widely available data point. You’ll find this alongside other stock price metrics when doing your research, which you should always do.

Advantages and disadvantages of using the beta version

Advantages

  • The story can contain important lessons: The beta version takes an important part of the data into account. With at least 36 months of measuring the stock’s highs and lows against the market, you’ll have a good idea of ​​what the road has been like so far for other investors.
  • The numbers don’t lie: Rather than perusing press releases on past product launches or trying to read between the lines of what a company’s CEO might have said on Investor Day last year, the beta is a math question.

The inconvenients

  • You look in the rearview mirror: Beta is a retrospective and unique measure that does not incorporate any other fundamental element or underlying information. Of course, it’s good to think about what the past three years have been like, but as an investor, what interests you is what awaits the next. Following three years. You want to think about the business outlook and potential market disruptions on the horizon.
  • Numbers don’t do everything: Beta does not include qualitative factors that can play an important role in a company’s outlook. Did this famous CEO resign in those three years? Now that the succession plan is in place, the future might be a little different.
  • The measure does not work with young companies: While a lot of hype swirls around IPOs, beta is a number that will never be part of the conversation. Because it’s calculated on historical price movements, you can’t use the beta to assess companies that intend to go public or start-ups that have recently been listed on Wall Street.


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