Takeaways
- Beta measures a stock's price movement relative to the overall market.
- Beta tracks a stock's shorter-term fluctuatoins relative to other assets.
- Beta greater than 1 means the stock is more volatile than the stock market.
- Beta is a variable in the Capital Asset Pricing Model used for investment analysis.
- Beta should be used with other financial indicators to get a complete view of a stock's potential performance.
What Is a Stock's Beta?
When analyzing stocks, investors often look for indicators that allow them to understand a stock's potential risk and return. One of the most used metrics for calculating a stock's volatility is a stock’s beta (β).
A stock's beta measures its volatility compared to the broader market, which has a beta of 1. Individual stocks are ranked on a scale, with a beta above one, indicating they move more than the market and below one, meaning they move less than the overall stock market.
Understanding beta is an excellent way to determine whether a particular stock fits within your risk tolerance and investment strategy. Whether you are a conservative investor who prefers steady growth or a risk-taker looking for high returns, knowing a stock's beta lets you make smarter choices.
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What Is a Stock's Beta?
Calculating beta involves using a statistical method called regression analysis. In most cases, analysts compare a stock's historical returns to the returns of a market benchmark, like the S&P 500. The formula for beta is:
Beta (β) = Covariance (Re, Rm) / Variance (Rm)
Where:
Re = Return of the stock
Rm = Return of the market
Covariance measures how the stock's returns move in relation to the market, while variance measures how much the market's returns vary over time. A beta greater than 1 indicates that the stock is more volatile than the market, while a beta of less than 1 suggests that the stock is less volatile.
Anything with Greek letters might be intimidating. Don’t worry; you don’t need to calculate a stock’s beta every time you want to research a stock. Instead, you can look it up for free on websites like Reuters or Yahoo Finance.
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Example of Beta
Let's say Stock A has a beta of 1.5. If the stock market increases by 10%, Stock A will rise by 15%, or 50% more than the market return. Likewise, if the market drops by 10%, Stock A may fall by 15%. This stock is considered more volatile than the market. Investors looking to capitalize on bull markets might want to capitalize on this correlation.
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On the other hand, with a beta of 0.7, Stock B would be expected to increase only 7% if the market goes up 10% or drop just 7% if the market declines 10%. A lower beta makes a stock less volatile and more stable during market downturns. Investors prefer less volatile assets when trying to hedge against bear market movements.
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What Is a Great Beta?
There's no universal “perfect” beta because it depends on your investment goals. A great stock beta slots into your investment portfolio based on your financial goals. Here's a look at the beta scale: [1]
Stock Beta Scale:
- Beta greater than 1: Stocks with high beta values tend to be more volatile and riskier. They may offer higher returns in bull markets but can suffer more significant losses during recessions or economic contraction. Aggressive investors favor these.
- Beta equal to 1: These stocks move in lockstep with the overall market. They have average risk and are a good fit for investors seeking balanced exposure. Index funds, mutual funds, and ETFs sometimes try to capture overall market returns. (Read about the Best Low-Risk Investments).
- Beta less than 1: These are less volatile than the market and more stable. Conservative investors or those looking to minimize risk during market turbulence may prefer these stocks.
There are 11 stock market sectors, each with its unique volatility profile. For example, some utility or consumer staple companies have betas below 1, reflecting their steady demand, regardless of market conditions. On the other hand, technology and growth stocks often have betas greater than 1 due to their higher risk-reward profile.
Limitations of Beta
While beta can be a helpful risk indicator, it has its flaws. Here are several to consider:
- Historical Nature: Beta is calculated using past data and may not accurately predict future movements. Additionally, beta is an evolving number.
- Ignores Fundamentals: Beta doesn’t provide any insight into a company's health, earnings stability, or competitive position.
- Not Suitable for All Stocks: Beta may not be meaningful or available for newly listed publicly traded companies or those with little trading history. A high beta might result from a fast-growing company or thinly traded stock.
- Market Conditions Change: A stock's beta can vary depending on the timeframe analyzed, market cycles, and the company's performance during that time.
A stock’s beta should be used as part of a broader stock evaluation strategy. Let's examine some metrics to help you with your investment analysis.
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3 Metrics for Analyzing Stocks
You should analyze investments with diverse financial metrics to get a complete picture of a stock's potential. Here are a few to consider:
Market Capitalization
Market capitalization, or market cap, refers to the total value of a company's outstanding shares. It's measured by multiplying the share price by the number of outstanding shares. Market cap gives investors a sense of a company's size and maturity. For example:
- Large capitalization: Stable, established companies, sometimes pay dividends, generally low beta stocks
- Mid capitalization: Growth potential with moderate risk, secured industry position, typically more moderate betas
- Small capitalization: Often more volatile, higher beta stocks.
Formula = Market cap = (Price per Share) (Outstanding Shares)
Great for diversifying your portfolio based on market size. Financial experts recommend having exposure to companies of different market caps.
Earnings Per Share (EPS) is a key measure of a company's profitability. It represents the portion of a company's profit allocated to each outstanding share of stock. Higher EPS typically indicates better performance and can influence investor confidence.
Formula: EPS = (Net Income - Dividends on Preferred Stock) / Average Outstanding Shares
Great for Retail and institutional investors who are analyzing companies. Consistently rising EPS over time is usually a positive sign.
Dividend Yield
Dividend Yield is the ratio of a company's annual dividend to its share price. It's expressed as a percentage and helps investors evaluate a stock's income-generating potential.
Formula: Dividend Yield = (Annual Dividend / Share Price) x 100
Great for fixed-income investors who often look for companies with stable or growing dividend yields, as these can provide steady cash flow.
Smart Summary
Beta is a valuable metric for assessing a stock's risk relative to the overall market. It helps you gauge volatility and choose stocks that match your risk tolerance. However, it shouldn't be used in isolation. Combining beta with other financial metrics like market cap, EPS, and dividend yield gives a more complete picture of a stock's value. Whether you're building a high-growth portfolio or a steady fixed-income investing stream, understanding these metrics will help you invest smarter.
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(1) BYU Library. Bloomberg Guide: Beta. Last Accessed April 7, 2025.
