Low Beta Investing
Friday, July 11th, 2008The prevailing market conditions present testing times for the investors. The market seems to lose in a week what it takes more than 3 months to gain, and the investors lose money rather quickly. In such a market, investors who are averse to losing money should look for rock-solid investments. By rock-solid, we mean stocks which are not too susceptible to the ups and downs of the market, and whose prices don’t free fall when the market crashes. These are low-beta stocks.
The beta of a stock is an indicator of the correlation between the movement of the market index and the movement of the stock price. For example, during a period, if the market index changes by 10% and the stock price changes by 6%, then the beta of the stock is 0.6. Hence, the stock price of a share having high beta would change faster than the market, and the price of a share having low beta would change lower than the market.
Thus, stocks with lower beta (beta < 0.5) would be less volatile than the market, and stocks having higher beta would be more volatile than the market. Hence, it would be prudent for a low risk investor to invest in low beta stocks when he expects the market to be volatile, as they hold up better during downturns. Such stocks have the potential to cushion losses in a bad market while allowing for the possibility of gains–though not as much as from high-beta stocks–in the event of a market revival. They make for great portfolio picks in bearish and uncertain markets.
One year returns (May 2007 to May 2008) for some low beta stocks:
The table above suggests that though there is merit in the low beta argument, an investment decision cannot be based solely on these criteria.
An investor should remember that beta is an indicator of the historical volatility of the stock. There is no guarantee that the stock will behave the same in the future as well. Having said that, most actively traded stocks do justice to their historical beta values. So, the next time you get ready to invest in a stock, do glance over its beta value.