The greater the risk, the greater the potential profit. This is a proverb associated with the stock market. Every investor who joins the stock market seeks the greatest possible return on their initial investment. However, equities with significant profit potential have a considerable risk of capital loss or value depreciation. In such circumstances, investors have little alternative but to assess their risk tolerance and invest in equities with limited risk exposure.
High-risk and growth investors may be interested in searching for high-growth, high-beta companies. High-beta stocks may be utilised to generate high profits, but they also carry substantial downside risk during market declines.
Understanding beta and its applications might be crucial for investors attempting to find the best-performing equities in the market. Below, we will examine the details of high beta stocks and everything related to them in a comprehensive and detailed manner.
Before diving into stocks with high beta, let’s look at the bigger picture and define beta. So, what are high beta stocks, and what does beta mean?
Beta is a statistical term that indicates the volatility of a stock’s price compared to an index representing the market, such as the High beta stocks Nifty or S&P. Essentially, it seeks to quantify how much the stock’s price will fluctuate in reaction to the market movements.
As the beta represents the stock’s volatility, it is used as an indication of risk.
In other words, it attempts to determine how much a stock can rise above the market when the market rises and how much it can fall below the market when markets correct. The greater a stock’s beta, the more it will climb during market rallies and decline during market corrections.
Thus the high beta stocks meaning is that the stocks which are much more unstable and carry greater risk. Beta is most often connected with capital asset pricing (CAPM), which is used to price stocks, where it serves as a measure of systematic risk. Thus various investments are valued based on the beta, the risk-free rate of return, and the risk premium.
High beta index corporations are more sensitive than the market as a whole. The beta of an individual stock quantifies its sensitivity. A beta of 1 shows that the asset follows the market. Less than 1 indicates a less unstable asset than the market, whereas larger than 1 indicates a more unstable asset.
A beta of 1.2, for instance, indicates that the asset is 20 per cent more unstable than the market. In contrast, a beta of 0.70 is 30 per cent more stable than the market. Beta is assessed relative to an index that is widely followed, such as the S&P 500 Index.
Beta Factor= Covariance ÷ Variamce
Beta is a factor of capital asset pricing (CAPM) used to determine the cost of equity investment. The CAPM formula employs the overall average rate of return and the beta profits of the business to calculate the rate of return that investors may anticipate depending on their perception of investment risk. In this manner, beta may affect a stock’s predicted return and share price.
Using regression analysis, beta is computed. It quantifies the propensity of a security or a portfolio to react to market fluctuations. The formula for determining beta is the covariance of an asset’s return with the baseline performance divided by the volatility of the benchmark’s return over a specific period.
You might be curious why investors invest in such stocks now that you know what high beta stocks are. It is because these stocks come with their own set of benefits that make them unique and more desirable than other stocks. You should be aware of what these benefits are.
High beta stocks, even though considerably risky compared to normal stocks, have many benefits that make them better than ordinary stocks.
Considering all the aspects, we can summarise the benefits of High beta stocks into a few points, which are as follows:
Now that we know the benefits, let us look at the advantages from a much broader perspective. For CAPM adherents, beta is helpful. When measuring risk, it is crucial to examine the price volatility of a stock.
Beta makes intuitive sense as a measure of risk, as it represents the probability of a stock losing value. Consider an early-stage technology stock with more price volatility than the market. It is tough not to believe that this stock will be riskier than a utility company with a low beta.
In addition, beta provides a simple, quantitative, and straightforward measurement. There are differences in beta based on factors such as the market index used and the measurement period. In general, the concept of beta is easy, and it is a valuable metric for calculating the costs of equity used in a valuation process.
While high beta stocks may indicate possibilities to catch upswings and generate substantial returns, particularly in rising markets, this would demand an active and alert strategy and prompt entrance and profit booking. To those for whom market timing is immaterial, there is no alternative to selecting equities with solid fundamentals and holding them.
In such a procedure, beta is also a crucial input as an indication of the stock’s potential contribution to the portfolio’s volatility. High beta equities in a portfolio may need to be balanced with low beta stocks that are more conservative. Beta, like all other indicators, cannot serve as the only foundation for investing choices.
A high beta stocks list improves a person’s wealth via considerable equity return rates. During an upswing in the stock market, this yield is possible when benchmark indices are increasing in value. Any slight change in such index values causes a substantial increase in the price of a high beta stock and, therefore, an increase in the portfolio’s value.
Stock price fluctuations are reliant on the index and not vice versa. Beta establishes the correlation between the stock price movement and the index movement. A stock with a beta of more than one is considered aggressive, whereas a stock with a beta of less than one is considered defensive. These bold and conservative categories are crucial to investment decisions when a portfolio manager seeks to control the portfolio’s beta.
They also act as a hedge when seen against inflation.
High beta stocks provide much higher returns than the country’s current inflation rate. This suggests that the actual worth of total investment will increase, resulting in a substantial increase in the buying power of individual investors.
These are all the necessary details about the advantages of high beta stocks, which allow them to be a better investment option than ordinary stocks. While it might seem significant on the surface, high beta stocks also have drawbacks.
The beta has various drawbacks when investing based on a stock’s characteristics. To begin with, beta does not include new information.
Think about a company, which we will call “Company A.” Company A is thought to be a defensive stock (A stock that produces reliable dividends and profits independent of the general stock market’s condition) with a low beta. When A started investing in stocks and took on more debt, its beta no longer showed the big risks it was taking.
Moreover, many technology companies are very new to the market and lack sufficient price history to develop a trustworthy beta. The inaccuracy of historical price movements as a prediction of the future is a further cause for concern. Betas are essentially rearview mirrors, reflecting only a little amount of what lies ahead.
Additionally, the beta value of a single stock tends to fluctuate over time, rendering it untrustworthy. Granted, beta is a decent risk indicator for traders seeking to purchase and sell equities within short time frames. However, it is less effective for investors with long-term goals.
The conventional definition of risk is the potential for loss. When investors evaluate risk, they assess the possibility that the value of the stocks they purchase may decline. The issue is that beta, as a risk indicator, does not differentiate between upward and downward price fluctuations. For most investors, downward movements represent a danger, and upward moves represent an opportunity. Beta does not assist investors in distinguishing between the two. For most investors, this makes little sense.
Value investors despise the concept of beta because it indicates that a company with a significant price decline is riskier than before the drop. A professional investor would claim that a firm offers a lesser-risk investment when it declines in price since investors may purchase the same shares at a lower price despite the subsequent increase in the stock’s beta. There is no correlation between beta and fundamental variables such as changes in corporate management, new service breakthroughs, or net income.
The other limitations of High beta stocks can be summarised into two broad spectrums, which are as follows:
Stocks with a beta value greater than one are particularly volatile since they are more sensitive to market movements. Consequently, any downturn in the stock market may result in significant losses for investors since a slight decline in benchmark points can result in a considerable reduction in the market value (price) of high-value securities.
The beta coefficient measures the rate at which a stock’s price swings about an underlying benchmark index. Thus, individuals get an accurate estimate of how their stock will perform relative to the general performance of the stock market. In such computations, only unsystematic risk characteristics such as stock market circumstances and economic variables are included.
Therefore, investors often face the danger of slipping into a value trap if the beta coefficient is the only criterion evaluated before selecting the best shares for investment. Even when the value of the benchmark index increases over time, the value of related securities may decline owing to poor management or the inability to reach production goals.
That sums up all the limitations high beta stocks have, which is not a major red flag to not invest in such stocks but is considerable enough to be noted. Now that you know about the pluses and minuses of high beta stocks, let us take a look at examples of some high beta stocks along with their recent performances in the market.
Whatever concept it may be, it becomes much easier to understand when you look at examples. We can consider indexes such as high beta stocks nifty which contain high beta stocks such as CG Power and Industrial Solutions which has a beta of 2.62, Indiabulls RE with Beta of 2.32, Reliance Capital with Beta of 2.43 and so on.
As instances of equities with betas in the vicinity of 2.5 that were members of the S&P 500 index, we examine three stocks from the recent years. Note that these examples are for illustrative reasons and are not meant to serve as financial advice. Below are some of the most noticeable high beta stocks:
AMD is a semiconductor business that competes with Intel and Qualcomm by manufacturing chipsets and microchips. In 2019, the value of AMD’s shares increased by more than twofold; as of June 2020, its market capitalisation is $53 billion. With a beta of 2.12, the business remained riskier than other S&P 500 equities during its positive run.
Silicon Valley Bank is owned and run by SVB Financial Group, which serves customers in this prosperous area of California. According to the company’s website, Silicon Valley Bank has helped finance over 30,000 startups, and SVB is included in the list of the nation’s central banks. Additionally, the bank is one of the leading suppliers of financial services to Napa Valley wine growers. Due to the company’s comparatively limited market and riskier customers, the stock had a beta of 2.25.
United Rentals is the world’s most significant equipment rental firm, primarily serving North American clients. Since its founding in 1997, URI has amassed a rental fleet of almost 700,000 pieces of heavy equipment valued at close to $15 billion. However, the firm works in a highly cyclical and commoditised sector. Slight variations significantly influence demand, such as those caused by contractions in the construction or building industries. Thus, the stock’s beta was 2.28.
From the above instances, it can be easily understood that high beta stocks have a similar market performance proportional to their beta values. Hopefully, these examples gave you a better understanding of high beta stocks and their relative trends.
Concluding thoughts
High beta stocks need intensive active management. Frequently, they are mature small- to mid-cap companies with high instability around significant announcements.
Individuals may invest in shares with a high beta if wealth creation is their primary objective, regardless of the risks involved. If the company’s management is good, shares with a beta greater than 1 are likely to deliver higher returns on the profitability of benchmark indexes. Extra technical analysis may be conducted using other similar terminology to prevent such high-risk rates.
Remember that trading in solid growth and high beta equities entails significant risks. Thus it is essential to monitor these assets and aim to counterbalance them with reduced-risk investment portfolios and funds for liquidity.
The above information provided you with a thorough understanding of how high beta stocks work. Having an explicit knowledge of High beta stocks can help you understand whether it is a good investment for you or not and can further reduce the risk associated with such volatile investments.
High beta stocks are great for those seeking to improve their wealth via investments in firms with significant development potential. Such investors may be considered risk-takers since they are willing to incur substantial risk in exchange for high returns on overall investment.
During the downturn in the stock market, investors may incur significant losses on their whole investment portfolio since such fluctuations significantly influence high beta shares with a coefficient value greater than 1. This is due to the increased dependency between the stock market and the relevant shares.
Because they are well-versed in the swings of the stock market and the tactics for navigating them, seasoned investors often seek opportunities to invest in high beta equities. They usually understand when to keep and sell their shares so that their money is exposed to little danger.
Therefore, experienced investors are best suited for high beta equities. To accurately anticipate the direction of share market fluctuations, extensive market research and analysis are necessary. Multiple elements are included in a corporation's internal management, and local circumstances inside a nation and global conditions must be examined to achieve a good return on overall investment.
Investors aim for the equities comprising a high beta index to achieve above-average investing returns. When the general stock market is strongly bullish, these investors often concentrate on high beta equities to maximise profits from the increased volatility that these stocks are anticipated to display.
However, the potential for greater profits comes with more risk since both gains and losses may be magnified relative to the broader stock market. During bear markets, investors prefer to avoid high beta equities since they may experience more significant losses than the market as a whole.
Several research shows that low beta companies outperform high beta stocks over the long run when risk is considered. However, this does not rule out the chances of investors achieving better returns on investment by maximising the volatility of high beta equities.
What is Systematic risk? Systematic risk is caused by macro issues and has a very consistent influence on all equities. They cannot thus be varied. For instance, if the government decides to demonetise the currency or hike interest rates, or if a major country like the U.S. is at war with another country, all stocks will be affected. You cannot spread this risk, so you must live with it.
Beta quantifies this systemic risk; the market often expects the portfolio manager to spread away from the unsystematic risk. Consequently, stock investors seek only compensation for systemic risk. This is why the beta is critical for portfolio management and investing decisions.
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