What Is the Beta of a Stock?

There are numerous financial figures to analyze when determining which stocks to buy, and the beta of a stock is one of the most important.

beta of a stockThat's because the beta of a stock indicates its volatility.

A beta of one (1) indicates the stock has the same volatility as the broader market and will therefore move with the market.

Anything higher than one means the stock is more volatile than the market. A stock with a beta of two or higher is considered a "high beta stock." A beta of less than one means the stock will experience less volatility than the market.

Most stock screeners provide the stock's beta for investors. Websites like Google Finance and Yahoo! Finance also provide this information.

But determining a stock's beta isn't the only thing you need to know. Investors also need to know how to apply this figure...

How to Analyze the Beta of a Stock

When analyzing the beta of a stock, you need to take into account the company's industry.

For instance, utility stocks tend to have low beta figures since that industry tends to have low volatility. Conversely, tech stocks typically have much higher beta figures.

Determining High or Low Beta

When looking at a stock's beta, a figure of one (1) is considered to be even with the market. This means the security is exactly as volatile as its index.

A beta of less than one indicates a stock that is considered to be less volatile than the market and is therefore a "safer" pick.

Beta figures over one indicate stocks that are more volatile than the market. Anything over two is considered a "high beta stock."

Take the utility stock Public Service Enterprise Group Inc. (NYSE: PEG), for example. It's a $20 billion electric and natural gas holding company with a beta of 0.57 according to Yahoo! Finance. To find out how that beta rates, you'd have to compare it to similar utility companies like Pepco Holdings Inc. (NYSE: POM) and its 0.27 beta. Both of these utility stocks have low betas compared to the market, but PEG is more than twice as volatile as POM.

The same thing applies when looking at a different industry, like tech. Ambarella Inc. (Nasdaq: AMBA) and Tesla Motors Inc. (Nasdaq: TSLA) have betas of 1.21 and 1.16, respectively, according to Yahoo! Finance. While those betas are above one, they are still low compared to small tech companies, which tend to have much higher betas. SanDisk Corp. (Nasdaq: SNDK), for example, has a beta of 2.09.

While the beta of a stock is great for determining volatility, it should not be the only figure you research when investing...

The Disadvantages of the Beta Figure

Beta figures are only historical, meaning they do not account for the future volatility of the company. This is the biggest disadvantage of the figure.

Say a company makes a major announcement that affects the future of the stock. If you only looked at the stock's beta, you would have no idea of future volatility.

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You'll encounter the same problem when looking at newly issued stocks. Since there is very little trading history, the beta figure will not tell the whole story.

That's why beta is best for short-term traders who are looking to capitalize on swings in the market. It is an accurate depiction of the short-term risk of investing in the stock, but it doesn't account for major changes to the company, its industry, or a competitor.

Finding the beta of a stock is an important piece of the puzzle when finding the best stocks to buy, but by no means should it be the only figure you research.

The Bottom Line: The beta of a stock is great for determining historical volatility. When researching beta figures, be sure to compare numbers based on other stocks in the company's industry. Unfortunately, beta does not predict the volatility of the stock, so it should not be the only figure you research.

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