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How to determine the risk of a stock

Feb. 29, 2024
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Fred Babu
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Fred Babu

One of the most important things to research about a stock prior to owning it is how RISKY it is.

 

There's a lot of ways to measure risk but one of the of the simplest ways is looking at something called "Beta"

The easiest way to describe beta is how sensitive a stock is to the overall movement of the entire stock market.

The HIGHER the beta of a company, the RISKIER it is relative to the market.

The LOWER the beta, the LESS risky it is to the market.

 

The beta of the entire market is 1.0

 

So if a company has a beta that is GREATER than 1.0, it is considered RISKIER than the market.

If it has a beta LESS than 1.0, it is considered LESS RISKY than the market.

Simple as that.

 

If a company has a beta of 1.2, that means it's 20% more risky than the market.

If the market is up 10%, the stock should be up around 12% on average.

If the market is down 10%, the stock will be down 12% in average.

 

On the flip side, if the company has a beta of 0.8, it is considered 20% less risky than the market.

If the market is up 20%, the stock may only be up 16%  but if the market is down 20% then the stock on average would only be down 16%.

If you are going to own a company with high beta, you need to be ready for some losses it the market as a whole takes a hit.

If you are going to own a company with low beta, you need to be comfortable with returns that may not be as high as the average market returns.

 

Keep in mind. Beta is not perfect.

It only measures the type of risk (systematic risk). It doesn't capture risk that is specific to the company and the company only (nonsystematic risk)

Also, beta can change over time so it's not a stagnant figure.

 

As an investor, it's important that you understand and research risk involved with an investment BEFOREHAND.

Beta is a great way of seeing how risky the investment has been in the past, compared to the market.

 

 


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