How should investors assess risk in the stocks they buy or sell? As you can imagine, the concept of risk is hard to pin down and factor into stock analysis and valuation.

Is there a rating — some sort of number, letter or phrase — that will do the trick? One of the most popular indicators of risk is a statistical measure called beta. Stock analysts use this measure all the time to get a sense of stocks' risk profiles. Here we shed some light on what the measure means for investors. While beta does say something about price risk, it has its limits for investors looking for fundamental risk factors.

Beta Beta is a measure of a stock's volatility in relation to the market. By definition, the market has a beta of 1. A stock that swings more than the market over time has a beta above 1. If a stock moves less than the market, the stock's beta is less than 1. High-beta stocks are supposed to be riskier but provide a potential for higher returns; low-beta stocks pose less risk but also lower returns.

Beta is a key component for the capital asset pricing model CAPMwhich is used to calculate the cost of equity. Recall that the cost of capital represents the discount rate used to arrive at the present value of a company's future cash flows. All things being equal, the higher a company's beta is, the higher its cost of capital discount rate.

The higher the discount rate, the lower the present value placed on the company's future cash flows. In short, beta can impact a company's share valuation. Advantages of Beta To followers of CAPM, beta is a useful measure. A stock's price variability is important to consider when assessing risk.

Indeed, if you think about risk as the possibility of a stock losing its value, beta has appeal as a proxy for risk. Intuitively, it makes plenty of sense. Think of an early-stage technology stock with a price that bounces up and down more than the market. It's hard not to think that stock will be riskier than, say, a safe-haven utility industry stock with a low beta.

Besides, beta offers a clear, quantifiable measure, which makes it easy to work with. Sure, there are variations on beta depending on things such as the market index used and the time period measured — but broadly speaking, the notion of beta is fairly straightforward. It's a convenient measure that can be used to calculate the costs of equity used in a valuation method that discounts cash flows.

Disadvantages of Beta However, if you are investing in a stock's fundamentals, beta has plenty of shortcomings. For starters, beta doesn't incorporate new information. Consider a utility company: Company X has been considered a defensive stock with a low beta. When it entered the merchant energy business and assumed high debt levels, X's historic beta no longer captured the substantial risks the company took on.

on the google finace chart for stock quote what does Beta mean? | Yahoo Answers

At the same time, many technology stocks are relatively new to the market and thus have insufficient price history to establish a reliable beta. Another troubling factor is that past price movements are very poor predictors of the future.

Betas are merely rear-view mirrors, reflecting very little of what lies ahead. Furthermore, the beta measure on a single stock tends to flip around over time, which makes it unreliable. Granted, for traders looking to buy and sell stocks within short time periods, beta is a fairly good risk metric.

However, for investors with long-term horizons, it's less useful. Re-Assessing Risk The well-worn definition of risk is the possibility of suffering a loss.

Of course, when investors consider risk, they are thinking about the chance that the stock they buy will decrease in binary option traders in australia. The trouble is that beta, as a proxy for risk, doesn't distinguish between upside and downside price movements. For most investors, downside movements are risk while upside ones mean opportunity. Beta doesn't help investors tell the difference.

For most investors, that doesn't make much sense. There is an interesting quote from Warren Buffett in regards to the academic community and its attitude towards value investing: A value investor would argue what does beta mean in a stock quote a company represents a lower-risk investment after it falls in value — investors can get the same stock at a lower price despite the rise in the stock's beta following its decline.

Beta says nothing about the price paid for the stock in relation to its future cash flows. If you are a fundamental investor, consider some practical recommendations offered by Benjamin Graham and his modern adherents. Try to spot well-run companies with a "margin of safety" — that is, an ability to withstand unpleasant surprises.

Some elements of safety come from the balance sheetlike having a low ratio of debt-to-total capital. Some come from consistency of growth, in earnings or dividends.

An important one comes from not overpaying.

Define stock brokers trading at low multiples of their earnings are safer than stocks at high multiples. Ultimately, it's important for investors to make the distinction between short-term risk — where beta and price volatility are useful — and longer-term, fundamental risk, where big-picture risk factors are more telling.

Earn money by viewing ads in pakistan betas may mean price volatility over the near term, but they don't always rule out long-term opportunities. Dictionary Term Of The Day. A measure of what it costs an investment company to operate a mutual fund.

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Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. Know The Risk By Ben McClure Updated January 3, — 6: We compare the Beta values obtained from financial sources. Also, how to compute Beta using Excel. In conjunction with stock valuation ratios like the price-to-earnings ratio and the price-to-earnings-growth ratio, a stock's measure of volatility known as beta can help investors build a diversified We explain two methods for calculating the beta of a private company.

The security market line graphs the systematic risk versus return of the whole market at a certain time, and shows all risky marketable securities. Learn how the bet against beta strategy is used by a large hedge fund to profit from a pricing anomaly in the stock market caused by high stock prices.

Beta is a measure of volatility.

Beta (finance) - Wikipedia

Find out what this means and how it affects your portfolio. Beta is a useful tool for calculating risk, but the formulas provided online aren't specific to you. Learn how to make your own. Check out five high-beta stocks that can help make your portfolio more exciting. Low beta may not necessarily mean low risk when it comes to some smart beta strategies. Check out five low-beta stocks that can help you to diversify your portfolio. Learn how beta is used to measure risk versus the stock market, and understand how it is calculated and used in the capital Learn about hedging strategies, how to delta and beta hedge a security and the difference between delta hedging and beta Learn how to calculate the beta of an investment using Microsoft Excel.

Alpha is a measurement of a portfolio manager's performance in relation to the overall market. Beta gauges the volatility Find out more about beta, what a stock's or portfolio's beta measures, and learn how to calculate a security's or portfolio's Learn about some of the quantitative finance measures that investors without a strong math background can use in analyzing An expense ratio is determined through an annual A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies.

A period of time in which all factors of production and costs are variable. In the long run, firms are able to adjust all A legal agreement created by the courts between two parties who did not have a previous obligation to each other.

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A statistical technique used to measure and quantify the level of financial risk within a firm or investment portfolio over No thanks, I prefer not making money. Content Library Articles Terms Videos Guides Slideshows FAQs Calculators Chart Advisor Stock Analysis Stock Simulator FXtrader Exam Prep Quizzer Net Worth Calculator.

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