January 9, 2007
Savvy investors should know what beta is, even if it has little impact on their investing lives.
Beta is a measure of a stock's volatility. A beta of 1.0 indicates a stock that rises and falls in sync with the overall market. A beta greater than 1.0 suggests wider swings, while a beta less than 1.0 indicates a sleepier stock.
Let's say the stock of Wart-B-Gone (Ticker: XWART) has a beta of 1.2. If the market as a whole advances 10% in a given period, we can expect Wart-B-Gone to advance 12%. If the market falls 20%, Wart-B-Gone can be expected to fall 24%.
Conversely, if United Velcronics (Ticker: UVELC) has a beta of 0.50, it is roughly half as volatile as the market. A market drop of 8% can be expected to depress UVELC about 4%. A market surge of 10% should move the company about 5%.
That seems relevant enough, and sounds professional enough, that The Motley Fool ought to support an intense focus on beta, right? Nope. We're contrary here as well. Since we prefer to hold stocks for the long term, short-term volatility doesn't faze us. Wart-B-Gone could have a beta of 2.5, even, and we might still happily buy it -- if we planned to hang on for years and years and had high expectations. Many stocks that have proven to be wonderful long-term investments have been very volatile in the short run.
You can learn more in our FAQ on beta and by scrolling way down to the feature article on beta in this news collection.