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Beta ()

Feb. 29, 2024
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Josh Viljoen
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Josh Viljoen

What is Beta () in Finance?

 

What is Beta ()?

In finance the beta () of a stock is a measurement of the volatility of the stock price relative to the market. Beta is used as a measure of risk and forms an important part of the Capital Asset Pricing Model.

 

The beta of a stock is expressed as a number and can be seen on most financial platforms on the summary section. See the attached image showing an example from Yahoo Finance of the beta of Apple.

 

Interpreting the Beta of a Stock

The beta of a companys stock can be interpreted as follows:

 

= 1 exactly as volatile as the market

>1 more volatile than the market

<1>0 less volatile than the market

= 0 uncorrelated to the market

<0 negatively correlated to the market

 

A stock beta of more than 1 is considered high and indicates that the stock is riskier than the market.  For example, Apple ($AAPL) has a beta a 1.23 which means that if the market (SP 500) had to rise or fall 10% during a given period of time, we would expect Apple stock would rise or fall 12.3% during the same time frame.

 

However, on the other hand a company like Coca Cola has a beta of less than 1 which is considered low and means that the stock is less risky than the market. Coca Cola ($KO) has a beta of 0.54 meaning if the market had to move by 10%, we would only expect the stock to move by 5.4%.

 

A stock can also have a negative beta. If a stock has a negative beta this means that the stock moves in the opposite direct to the market. An example of this Zoom Video Communications ($ZM) which currently has a beta of -0.61.

 

How to incorporate Beta into your investment strategy

If you are an investor looking to reduce the risk in your portfolio then adding some low beta stocks to your portfolio is a great way to reduce the amount of volatility in your portfolio. Using the beta of a stock can help you tailor your investment portfolio to match your risk profile.

 

Alternatively, if you are looking for greater risk in pursuit of greater returns then you may find yourself gravitating towards stock with a high beta like Tesla which has a beta of 2.18. 

 

It is important to note that betas of stocks will vary across industries. Thus, when using beta to assess an investment it is important to compare the beta of the stock to the beta of that particular industry. In the example highlighted earlier we look at the betas of Coca Cola and Apple. This however is not a fair comparison as Coca Cola is in the beverage industry while Apple is in the technology sector. Thus comparing the beta of Coca Cola to other beverage companies would be an appropriate method to assess the risk of the stock relative to the market.

 

Aswath Damodaran publishes a list of stock betas by sector on an annual basis that can be accessed using the following link.

 

 

 

 

 


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