Understanding Beta for a Company
Beta is a measure that can be used to understand how volatile a specific company’s stock price is relative to the overall market. In general, a company can either be riskier than the market, same risk as the market, or less risky than the market.
Without having the company’s beta or calculating the beta, we can compare the % change in a company’s stock price against the % change in the market to determine if the company has a beta greater than 1, equal to 1, or less than 1.
Let’s go through an example for each scenario:
A) Greater % change – Let’s say that company’s stock changes 5% (up or down) while the market only changes 3% (up or down). In this case, the beta would would be greater than 1 because the company’s stock changed more than the market. A company with a beta greater than 1 is considered to be more risky because the stock would be more volatile.
B) Equal % change – Let’s say that the company’s stock changes 3% (up or down) and the market changes 3% (up or down). Since the company’s stock price and market moved the exact same amount, the beta would be equal to 1. This means that the company is no riskier or no safer than the overall market.
C) Smaller % change – Let’s say that the company’s stock price changed 3% (up or down) while the market changes 5% (up or down). In this case, the beta would be less than 1 because the market changed more than the company’s stock price. A company with a beta greater than 1 is considered to be less risk because the stock is less volatile.
Is a beta greater than 1 or less than 1 better?
There is no answer to this question. Every investor has to assess their own risk appetite. Investing in a company with a beta greater than 1 is enticing because the stock price could increase more than the market, but it could also decrease more than the market.
If your appetite for risk is low, then you are better off investing in company’s with a beta less than 1 as the stock price will be less volatile than the market.
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