Investing Beta and Other Investment Cues

investing beta

If you’re an investor, you probably know that beta is a measure of stock price volatility. It tells you how much a stock moves in relation to the market, and it’s one of the factors used in the capital asset pricing model (CAPM) to determine expected risk-reward. However, it’s not a perfect indicator of how stocks will perform in the future. There are several reasons why you should consider using other investment cues in addition to beta.

A stock’s beta is a measure of its volatility in comparison to the market, and it’s calculated by multiplying a security’s covariance with the variance of the market, usually represented by an index like the Standard and Poor’s 500 Index. A lower beta means a stock is less volatile than the market, while a higher beta means it’s more volatile than the market. Utility and real estate stocks, for example, tend to have low betas, while technology companies and early-stage growth stocks have high betas.

In practice, beta is a useful tool for investors who are looking to diversify their portfolios. Choosing stocks with different betas helps them minimize their overall risk while still giving them the opportunity to earn great returns. If you’re a risk-averse investor who wants to limit your losses, low-beta stocks are ideal. But if you have a high tolerance for risk, you may want to look at stocks with higher betas.

Besides being a helpful diversification tool, knowing a stock’s beta can help you understand how to interpret its past performance. If a stock has a high beta, it’s likely that it’s more volatile than the market, and it will see greater fluctuations in both upward and downward direction. Conversely, a stock with a low beta will have a more stable price movement and less potential for significant gains.

It’s important to remember that beta only reflects historical risk and doesn’t predict the future. For example, a stock’s past behavior can change its beta score in an unpredictable way, such as when it experiences a merger or other major event. Similarly, the market’s overall trend can affect beta in unexpected ways.

In addition, a stock’s beta can be affected by its financial leverage, or how much of its earnings it commits to paying interest on debt. This increases the risk of a company’s shares, but it doesn’t reflect other types of industry or business risks. For this reason, you should also look at a stock’s unlevered beta when researching it. It’s a more accurate indicator of the level of risk associated with a stock.