If you've spent any time around sophisticated investors, you've probably heard the term "beta," and you may have wondered what it means. Basically, it's a measure of a stock's volatility. A beta of 1 indicates a stock that rises and falls in sync with the overall market. A beta greater than 1 suggests wider swings, while a beta less than 1 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 0.5, 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 in this area as well. Since we prefer to hold stocks for the long term, short-term volatility doesn't faze us. Even if Wart-B-Gone had a beta of 2.5, we might still happily buy it -- if we planned to hang on for years and years and had high expectations. Many stocks that have turned out to be wonderful long-term investments have been very volatile in the short run.
Besides, even low volatility doesn't guarantee good results from a stock. If the company runs into big trouble, its stock is headed south no matter what its beta is.
You can learn more in our FAQ on beta and in these articles:
- Ben McClure: "Rumblings on Risk"
- Nathan Slaughter: "6 Stocks for the Next Sick Market"
- James Early: "Present Value for Pretenders"
Also of possible interest is this article on how beta can help Drip investors.
To learn more about how to make sense of financial statements, check out our "Crack the Code: Read Financial Statements Like a Pro" how-to guide (also known as an online seminar). Give any of ourhow-to guides a whirl, for that matter. More than 90% of those who've taken them have consistently given them high marks -- and besides, we offer a money-back satisfaction guarantee.
