The Beta Coefficient is a means of measuring the volatility of a security or of an investing portfolio of securities in comparison with the market as a whole.
In other words, Beta is the sensitivity of a stock’s returns to the returns on some market index.
Beta is calculated using regression analysis. A Beta of 1 indicates that the security’s price will move with the market.
A Beta greater than 1 indicates that the security’s price will be more volatile than the market and finally, a Beta less than 1 means that it will be less volatile than the market.
Beta values can be roughly characterized as follows:
* b Less than 0:
Negative Beta is possible but not likely. People thought gold stocks should have negative Betas but that hasn’t been true.
* b Equal to 0:
Cash under your mattress, assuming no inflation!
* Beta Between 0 and 1:
Low-volatility investments (e.g., utility stocks).
* b Equal to 1:
Matching the index.
* b Greater than 1:
Anything more volatile than the index.
* b Much Greater than 1:
Impossible, because the stock would be expected to go to zero on any market decline.
Most new high-tech stocks have a Beta greater than one, they offer a higher rate of return but they are also very risky.
The Beta is a good indicator of how risky a stock is.
The more risky a stock is, the more its Beta moves upward. A low-Beta stock will protect you in a general downturn.
That’s how it is supposed to work, anyway!
Unfortunately, past behavior offers no guarantees about the future. Therefore, if a company’s prospects change for better or worse, then its Beta is likely to change, too.
So, be extremely cautious and use the Beta Coefficient only as a guide to a stock’s tendencies …
Not as a crystal ball!