Beta is a measure used in fundamental analysis to determine the volatility or portfolio of assets relative to the market as a whole.
Overall, the market is version 1.0, and individual stocks are ranked according to how much they deviate from the market. A stock that swings more than the market during a beta greater than 1.0. If the stock moves less than the market beta of the stock is less than 1.0. High beta stocks tend to be riskier but provide a potential for higher returns; low-beta stocks are less risky but generally provide lower returns.
As a result, beta is often used as a risk-reward measure means that it helps investors determine how much risk they are willing to take to achieve in exchange for the assumption of risk. The variability of stock prices should be considered in the risk assessment. If you believe that risk as the possibility of a stock losing its value, beta of appeal as a proxy for risk. For more in-depth look at how beta is used in the risk analysis, please read beta: know the risk.
How to calculate beta
To calculate the beta of the securities, the covariance between returns on security and market return should be known, as well as the variance of the market yield.
- Covariance measures how two stocks move together. A positive covariance means that stocks tend to move together, when their price will go up or down. A negative covariance means that stocks are moving opposite each other.
- Dispersion, on the other hand, refers to how far a stock moves relative to its mean value. For example, the variance is used to measure the volatility of the individual stocks over time. Covariance is a measure of the correlation of the price movements of two different stocks.
The formula for calculating beta is the covariance of asset return with the return of the benchmark divided by the variance of return of the benchmark over a specified period.
Similarly, beta can be calculated by first dividing the safety standard deviation standard standard deviation of return. The resulting value is multiplied by the ratio of the yield of securities and returns a reference.
Calculation Of Beta For Apple. (With slight changes):
The investor is looking to calculate beta from Apple. (Aapl), as compared to a Fund spdr s&P 500 in real-time trust (spy).
Based on data over the past five years, the ratio of the output, and a spy is 0.83. The company has a standard deviation of returns of 23.42% and spy has a standard deviation of returns 32.21%.
The beta of the stock aapl = 0.83 x (0.2342 ÷ 0.3221) = 0.6035
In this case, Apple is less volatile than the stock market funds (etf), as it is a beta version 0.6035 indicates that the stock theoretically experience 40% less volatility than a Fund spdr s&P 500 exchange-Traded Fund trust.
Calculation Of Beta For Tesla Inc. (CLA):
Suppose the investor wants to calculate the beta of Tesla motors Inc. (CLA) in comparison with the Fund spdr s&P 500 in real-time trust (spy). Based on data over the past five years, TSLA & spy are 0.032 covariance, and variance 0.015 spy.
Beta CLA =0.032 ÷ 0.015 = 2.13
Therefore, CLA is theoretically 113% more volatile than a Fund spdr s&P 500 in real-time trust.
Beta to vary between companies and industries. Many utilities stocks, for example, a beta less than 1. Conversely, most high-tech, Nasdaq-based stocks with beta greater than 1, that enables a higher rate of return, but also creates more risk.
It is important that investors distinguish between short-term risks; where beta and price volatility are useful; and long-term risks, where the fundamental (big picture) risk factors are more common.
Looking for investors with low risk may gravitate toward low-beta stocks, which means that their prices will not fall as much as the overall market during the recession. However, those same stocks will not rise as much as the market as a whole during lifting. By calculating and comparing the coefficients of beta, investors can determine their optimal risk-reward ratio for your portfolio.