Investing in the stock market comes with inherent risks and rewards. The general consensus is that a volatile stock is a risky bet, but at the same time it has the potential of generating higher returns. Now the question arises – what standard should we use to gauge whether a stock’s volatility is on the higher side or not. That’s where the Beta value of a stock becomes helpful. Read on, to know what high beta stocks are and whether you should invest in them.
How To Calculate the Beta of a Stock
Beta of a stock is calculated using a statistical method called regression. In order to calculate the beta of stocks you can use built in Excel functions like SLOPE, VAR, and COVAR. These functions can help you calculate the beta of any stock with relation to an index easily. To use these functions, you will have to get the daily returns of the stock (E.g. Tata Motors) and the index (E.g. Nifty 50) for a specific period (E.g. last 1yr) – these can be calculated using their closing prices. Once you have them, use either of the following formula to calculate the beta:
- SLOPE(index daily returns, stock daily returns) or
- COVAR(index daily returns, stock daily returns)/ VAR(index daily returns)
What Does the Beta of a Stock Actually Imply?
So, why do we calculate the Beta of a stock? The Beta of a stock indicates how volatile a stock is relative to the market. Market here is the broad market index relative to which you have calculated the beta of the stock.
- A Beta of more than 1.0 indicates that the stock is more volatile than the market. For example, if COALINDIA has a beta of 1.59 (N50), it is expected to move by 15.9% when Nifty50 moves by 10%.
- A Beta of less than 1.0 indicates that the stock is less volatile than the market while a beta of 1.0 indicates the stock generally tends to move with the broader market. For example, if CEAT has a beta of 0.7 (N50), it is expected to fall by only 7% when Nifty50 falls by 10%.
- Negative beta indicates that a security moves in the opposite direction of the broader market while a 0 beta indicates no correlation.
High Beta Stocks and Their Features
High Beta stocks are those that have a Beta value of more than 1.0. These stocks tend to be more volatile compared to the broad market. The risks of investing in them are higher, and the potential returns are higher as well. Here are 5 features of high Beta stocks:
- Larger Price Swings: High beta stocks display larger price swings compared to the broader market. During the bull run, these stocks can be expected to move higher that the broader market and generate significant profits for the investors, but during downturns, the same stocks can fall more than the market.
- High Risk-Reward Ratio: Investing in high-beta stocks comes with a high risk-reward ratio. The potential for both downside and upside is high. Investing in them comes with the possibility of both comparatively significant profit as well as comparatively significant loss.
- Small and Midcap Stocks Generally Have a Higher Beta Value: Not all, but many high Beta stocks have a small to medium market capitalisation. Since these groups of stocks are more sensitive to changes in the market and the economy, their prices tend to be more volatile. A highly volatile stock tends to have a high beta.
The Case for and Against Investing in High Beta Stocks
Your decision of investing in high Beta stocks depends on your risk appetite. Investing in such stocks comes with a greater risk to your deployed capital. However, every investment strategy comes with both pros and cons.
Who Should Invest in High Beta Stocks and Why
High beta stocks are particularly appealing to short-term traders, growth investors, and those seeking to diversify their portfolios. For short-term traders, these stocks offer the potential for substantial gains due to their heightened price volatility, which can lead to significant profit opportunities in a shorter timeframe. Growth investors, who focus on companies with the potential for above-average earnings increases, may find high beta stocks attractive as they exhibit wider price movements improving the returns of the portfolio. Additionally, high beta stocks can serve as effective diversifiers in a portfolio, especially during bullish market phases, by potentially enhancing returns and balancing exposure to different market dynamics. However, the increased volatility associated with these stocks also means greater risk, making them more suitable for investors with a higher risk tolerance.
Who Should Not Invest in High Beta Stocks
Conservative or new investors should avoid high beta stocks or limit their exposure to these investments due to their increased volatility and potential for significant losses rapidly.
For long-term, fundamental-based investors, focusing solely on beta of a stock is generally not advisable. Remember that beta is just a metric to understand the relative risk in a stock and should not be the primary factors driving your investment decisions. Fundamental aspects of the company, its valuation, competitive advantage, business model, management, etc. are some of the important factors to consider while investing in a stock.
You should consider the beta of individual stocks within the broader context of your entire portfolio. Beta is more effectively used on a portfolio level to gauge overall volatility and understand the relative risk of the portfolio.
People who might not like high beta stocks can still take advantage of the beta value to find out stocks having low volatility. For such people smart beta stocks might be of interest.
How To Find High Beta Stocks in The Indian Market
Another way of finding high-Beta stocks is to use screeners. There are many free stock screeners available on the internet that list all the high-Beta stocks in the India market – segregated by daily, weekly and monthly returns data.
You can also use a simple Google Sheet formula to find the beta of any stock. For example, if you want to see the Beta value of the Infosys stock, use this formula: =GOOGLEFINANCE(“NSE:INFY”, “beta”)
Bottomline
Investing in high-Beta stocks comes with significant risks. Please make sure that you don’t get swayed by the promise of high returns and end up losing a significant amount of your hard-earned money. You can invest a part of your capital in these high-risk stocks, but even then, do your due diligence and invest for the long term. You will find many high Beta stocks with questionable fundamentals or poor liquidity due to very few buyers or sellers. It is better to avoid them. The bottomline is that don’t get swayed by the promise of high returns. Keep your expectations low and, in the end, if you do get high returns, then that’s awesome!
