Once you’ve calculated the beta of a stock, it can then be used to tell you the relative correspondence of price movements in that stock, given the price movements in the broader market as a whole. The beta of individual stocks is often listed as a key statistic in the summary section of stock quotations. However, you can calculate beta on your own, whether for a single stock or an entire portfolio of stocks. Systematic risk, or total market risk, is price volatility that affects stocks across many industries, sectors, and asset classes.
Second, investors are interested in the best forecast of the true prevailing beta most indicative of the most likely future beta realization and not in the historical market-beta. A negative beta correlation would mean an investment that moves in the opposite direction from the stock market. When the market rises, then a negative-beta investment generally falls. When the market falls, then the negative-beta investment will tend to rise. The most rudimentary way to use beta is to realize that high beta stocks could increase your portfolio risk while low beta stocks could reduce it. Beta (β) is the second letter of the Greek alphabet used to measure the volatility of a security or portfolio compared to the S&P 500 which has a beta of 1.0.
If the market decreases by 2%, the portfolio generally decreases by 4%. You’ll find this alongside other metrics of a stock’s price when doing your research — which you should always do. There is no single answer to the question, “what is a good beta? ” It depends on what you’re trying to do to your portfolio and how an investment with a high or low beta will affect it.
Beta says nothing about the price paid for the stock in relation to fundamental factors like changes in company leadership, new product discoveries, or future cash flows. Small-cap and technology stocks typically have higher betas than the market benchmark. Adding this type of stock to a portfolio will raise its risk, but it may also improve its expected return. According to the CAPM, the expected returns from stock have two components. The equity risk premium here is derived by subtracting risk-free return from the expected market return. It measures the volatility of the stock compared to the broader markets.
Covariance
- High-beta stocks are supposed to be riskier but provide higher return potential.
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- It’s hard not to think that stock will be riskier than, say, a safe-haven utility industry stock with a low beta.
- Anything that can affect the market as a whole, good or bad, is likely to affect a high-beta stock.
- First, beta is calculated using historical market data so it’s less useful for investors who want to predict future movements in prices.
Beta is a part of the CAPM (Capital Asset Pricing Model), which is the most widely used asset pricing model. Note that beta can also be calculated by running a linear regression on a stock’s returns compared to the market using the capital asset pricing model (CAPM). Beta allows for a good comparison between an individual stock and a market-tracking index fund, but it doesn’t offer a complete portrait of a stock’s risk. Instead, it’s a look at its level of volatility, and it’s important to note that volatility can be good and bad. The downward price movement, of course, will keep people up at night.
Doing this yields the amount of systemic risk a security introduces into a portfolio and how that risk could impact the expected return. Beta is a term used in finance to measure the volatility, or systematic risk, of a security or portfolio in comparison to the market as a whole. It’s a key component of the Capital Asset Pricing Model (CAPM), an equation used to determine the expected return on an asset. Covariance is a measure of how two securities move in relation to one another. Are there actual investments out there that have negative betas? In fact, in my 15 years of updating betas by sector, I have still not found a sector with a negative beta.
Beta Risk vs. Beta
However, based on its actual performance, the stock outperformed the S&P 500 by 8%. One year later, Stock OW gained an annual return of 20% while the S&P 500 only grew by 12%. In this case, Stock OW has a positive alpha because the investor earned more than the projected investment risk. Both companies presented have betas of less than one, meaning that they are less volatile than the market in general. However, Coca-Cola’s slightly higher beta means it might be a bit more volatile than Nike. Once you have calculated the beta, you need to interpret the value to understand the stock’s risk.
A stock’s beta will change over time as it relates a stock’s performance to the returns of the overall market. For beta to provide useful insight, the market used as a benchmark should be related to the stock. For example, a bond ETF’s beta with the S&P 500 as the benchmark would not be helpful to an investor because bonds and stocks are too can beta be negative dissimilar.
Can beta be negative?
Beta can help give investors an idea of the risk in a given stock, and it’s a useful, if incomplete, way of doing so. We are an independent, advertising-supported comparison service. Beta analysis can be a useful way to manage the level of risk in your portfolio, but like any financial technique, it’s not perfect. You don’t need to do college-level statistical calculations by hand to find a stock’s beta (unless you want to, for some reason). That is, if a portfolio consists of 80% asset A and 20% asset B, then the beta of the portfolio is 80% times the beta of asset A and 20% times the beta of asset B.
Beta and alpha can help analysts review past investments and plan for new ones when taken together. A beta of 1.0 implies that the stock is highly correlated with the market. For example, as of Oct. 27, 2020, the beta for Microsoft (MSFT), as found on Yahoo! Finance, is 0.92. No matter how good or bad the economic indicators are, people are going to continue to buy Tide detergent and Olay soap in roughly the same amounts.