Investing Essentials: High-Beta Stocks

High-beta stocks are stocks that tend to be more volatile, but focusing on volatility alone can can lead you to miss the bigger picture.

Aug 21, 2014 at 10:12AM

Coins Pd

High-beta stocks are often considered risky, and at times they are. However, investors should understand the difference between risk and beta, because while the risk level of a stock is sometimes reflected in its beta, there's more to the story. Let's take a closer look at what beta is and what purpose high-beta stocks can serve. As an investor, it's critically important that you really have a good grasp of this concept so that you can more effectively use the beta metric when evaluating a stock for your portfolio.

Before we dive into high-beta stocks, let's briefly go over what beta really means.

What beta means

Beta measures how much a stock price tends to move in either direction compared to a benchmark. Typically, that benchmark is the broader stock market or S&P 500, but it can also be an industry or an index of companies similar in size. Beta is a measure of volatility, not a measure of risk.

The beta scale works like this. A stock with a beta of 1 has moved in lockstep with its benchmark over the measured period of time. A beta of less than 1 means the stock was less volatile than its benchmark, while a number greater than 1 means it was more volatile, exaggerating the benchmark's moves. Meanwhile, a stock with a negative beta tends to move in the opposite direction of its benchmark.

It's also important to understand which beta measure you're looking at. The most typical beta metric listed with a stock quote is its three-year beta versus the market, but this can be different from one source to the next.

What are high-beta stocks?

A high-beta stock, quite simply, is a stock that has been much more volatile than the index it's being measured against. A stock with a beta above 2 -- meaning that the stock will typically move twice as much as the market does -- is generally considered a high-beta stock. High betas are typical of small, speculative companies -- e.g., biotech companies that are developing new treatments and small tech stocks with hot new technologies that have big potential but small market share. Because the price of these sorts of stocks can swing wildly, and often on little more than speculation, this volatility can make the shares seem risky if the shareholder reacts to the price movement and sells at a loss. 

Beta is often used as a proxy for risk, and indeed high-beta stocks often carry more risk, but a high beta doesn't guarantee high risk any more than low beta guarantees low risk. Before we talk any more about beta and risk, let's define risk as the likelihood of a permanent loss of capital

Here's an example of how risk and beta don't always align. Let's say you could invest in either of the following:

  • Company A has been in business for almost 100 years, with expertise that makes it a leader in a fast-growing global market. The stock has been volatile, but the business' balance sheet is solid, and the company has a long history as a supplier to major players in this growing space. It has grown sales more than double since 2010.
  • Company B faces stiff competition in its business, has few competitive advantages, and faces the threat of declining market share as consumer tastes shift away from its offerings, as evidenced by its minimal growth of sales -- only 26% since 2010, significantly lower than its peers. With similar revenue to Company A, Company B generates less than half the net income while carrying only about 40% as much cash on its balance sheet.

Which of these two would you expect to carry more risk of permanent loss of capital?

If you said Company B -- Red Robin Gourmet Burgers -- you'd probably be right. However, the restaurant chain had a beta of about 1.3 at the start of the year, while company A -- Chart Industries -- had a beta around 2.4 and has consistently carried a higher beta for years. Only in recent months have these companies' betas begun changing course: 

RRGB Beta Chart

RRGB Beta data by YCharts.

Red Robin faces serious long-term competitive threats to the viability of its business, while Chart Industries is a recognized global leader in the industrial cryogenic liquids processing business. Those risks didn't just show up this year, either, so in many ways, beta is more of a trailing metric, reporting past volatility rather than today's risk. 

Real-world business challenges are not factored into beta, but rather mere market volatility, which is a measure of the market's perception of risk and is short-term in nature. 

A few words on business-focused investing 

While beta can be a helpful metric when used in combination with other tools, remember that it's only a measure of past volatility against an index -- not a measure of safety. When researching any stock, study the whole business, looking for durable advantages. Never rely on metrics alone to tell you whether a company makes a good investment. 

The next big wave you don't want to miss
You know cable's going away. But do you know how to profit? There's $2.2 trillion out there to be had. Currently, cable grabs a big piece of it. That won't last. And when cable falters, three companies are poised to benefit. Click here for their names. Hint: They're not Netflix, Google, or Apple.

Jason Hall owns shares of 3D Systems, Apple, Google (A shares), Netflix, and Stratasys. The Motley Fool recommends 3D Systems, Apple, Google (A shares), Netflix, and Stratasys. The Motley Fool owns shares of 3D Systems, Apple, General Electric Company, Google (A shares), Netflix, and Stratasys. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers