Beta value is also used as a measure of an asset’s risk relative to that benchmark. The beta of a stock tells an investor how much the stock is moved compared to the general stock market it trades in.
The relation between the beta of stock and the return is directly proportional to each other. Meaning the higher the beta of any stock, the better-expected return from it.
The Beta value infographics by Kamlesh Rode
What is Beta Value?
Beta is one of the best indicators of volatility in the price of an investment to the overall markets as represented by a benchmark. A beta of 1 shows that investment is in line with the market movement. The relation between the beta of stock and the return is directly proportional to each other. It means the higher the beta of any stock, the better-expected return from it.
A beta greater than 1 indicated the investment is more volatile than the market and less than 1 denotes less volatility. For example, if the markets went up by 10%, a stock with a Beta of 1.2 will go up by 12% (10% x 1.2) but it will also fall more when markets decline. A stock with a Beta of less than 1 will go up and down less relative to market swings.
Example: If we take Beta as a beta (बेटा) word in the Hindi language (son) of a father (here the father is Market). The Beta value with respect to the market is like the father and son relation. If the father is moving then the son is also moving along with him. If the father allows his son to play freely then the value of beta increases and if the father is not allowed much then the beta value is less, it can be less than one.
Detailed analysis of beta value
Beta is a measure of a market or non-diversifiable risk in a stock or a portfolio. It was a statistical measure of on average how much would a stock or portfolio went up or down relative to the market. A beta of 2 implies that on average if the market went up by 1% (above the risk-free rate), a stock would go up by 2% (above the risk-free rate) and vice versa.
Beta Interpretation
In ordered to get the maximum out of it, there was always a needed to interpret it properly, without which the entire purpose of it may not be served. Different values of data stand for different things. For your reference here is a quick description of each data value:
• Beta valued 1: a beta value of 1 means that the stock returned was as per the market standards. You could be expected that when the market soars, the stock also would soar, whereas when the market would dip, the price of the stock too would dip. However, this did not necessarily mean that such stock was risk-free as the market itself had a certain level of risk
• Beta value of less than 1 but more than 0: these were the stocks that did not have too much risk associated with it. Additionally, these were also only marginally affected in times of wild market swings. However, its risk-free trait means that returned too were even lowered than the market returned. Non-cyclical or defensive stocks fell under this category.
• Beta value more than 1: these were the high-risk but high-return stocks. Technology stocks fell under this
• Negative beta: these were the stocks that tended to go down even when the market was on an upward curve. They were also known as decaying stocks
• 0 Beta: any financial asset that was unrelated to the stock market fell under this criteria
How Beta is calculated and formula?
Beta is also used as a measure of an asset’s risk relative to that benchmark. The beta of a stock tells an investor how much a stock moved compared to the general stock market it trades in. Stock’s beta is calculated as the division of covariance of the stock’s returned and the benchmark’s returned by the variance of the benchmark’s returned over a predefined period
Stock Beta Formula = COV(Rs,RM) / VAR(Rm)
where,
• Rs refers to the returns of the stock
• Rm refers to the returns of the market as a whole or the underlying benchmark used for comparison
• Cov(Rs, Rm) refers to the covariance of the stock and market
• Var(Rm) refers to the Variance of market
What were high beta stocks?
In the stock markets, beta tells about the sensitivity or movement of a stock or playing with respect to the real-time changes with the stock market. The beta of any index e.g NSE was considered 1. The stocks (reliance, infy, etc. ) having a beta of more than 1 were considered high beta stocks.
High beta stocks referred to those stocks whose prices were very volatile. High-beta stocks were supposed to have been riskier but were the potential to provide a higher return. High-beta investments tended to outperform the market when the market was gone up, they also would accelerate their losses when the market moved down.
In simple terms, high beta refers to stocks whose prices were very volatile. Their prices went up and down sharply. Hence these stocks were considered pretty riskier.
For example: let us said the beta of Bajaj Finance was 1. 5, it means that if Sensex (BSE, NSE) moved by 1% then it was highly likely that Bajaj Finance would be moved by 1. 5% and if Sensex went down by -1% then Bajaj Finance would go down by -1. 5%
Stock Market example of a Beta Stock
The Beta of the market is defined as 1.0. Individual stocks, ETFs, or mutual funds could have a Beta > 1.0, implying greater volatility than the market. A Beta that is < 1.0 means the stock is less volatile than the market as a whole.
Beta uses regression analysis to arrive at its measurement. Beta doesn’t anticipate or predict future movements or volatility.
A stock with a beta of 0.47, like AT&T, is half as volatile as the market and will underperform by 50% if the market rises or drop by less than half during a market downturn. This is theoretical, of course, since analysis is not in future prediction. For a company like AT&T that has been around for dozens of years and has a lot of history, the Beta measurement is safer for predicting the future.
I tend to prefer stocks with Betas but 1.0. I do own AT&T which has a Beta of 0.47; Realty Income which has a Beta of 0.17; LTC that has a Beta of 0.11; STAG that has a Beta of 1.43; BEP, a Beta of 0.23; and CHTC that has no Beta as yet.
Conclusion
Beta may be a measure of the volatility within the price of an investment relative to the general market as represented by a benchmark. A Beta of 1 indicates that the investment will move in line with market movement. A Beta greater than 1 indicates the investment is more volatile than the market and less than 1 indicates less volatility
Why beta value is so important in the fundamental analysis of the stock? Please read the fundamental analysis with infographics.
Frequently asked questions(FAQs)
Ans: A stock with less than 1 beta value indicates that the stock is less volatile than the index. These stocks are not very risky or less risky stocks.
Ans: A high beta stock means the stock is very sensitive to stock market news and information. It will move faster than lower beta value stocks. Generally, high beta stocks are highly risky. But high beta stocks give good returns than lower beta stocks. Choosing high or low beta stocks totally depends on the psychology of the investor.
Ans: A high beta index refers to a market index that is made up of stocks with higher-than-average volatility as compared to the overall stock market. A high beta stock means the stock is very sensitive to stock market news and information. It will move faster than lower beta value stocks
Ans:
β =1 exactly as volatile as the market.
β >1 more volatile than the market.
β <1>0 less volatile than the market.
β =0 uncorrelated to the market.
β <0 negatively correlated to the market.
