11.4 Beta & risk


The beta is a measure of a stock's price volatility in relation to the rest of the market. In other words, how does the stock's price move relative to the overall market? To put it briefly, the Beta (B) of a share is a measure which reflects the sensitivity of the return on the security vis-a-vis the market return. The market return is the return you get by investing in the 30 shares which constitute the BSE index. Suppose, there is a share whose Beta is 3. It means that if the market returns increase by 10 per cent then the return from that share will increase by three times i.e. 30 per cent. So the share outperforms the 30 BSE shares in the rising market. But what if the market falls? If the market return falls by 10 per cent, this scrip's fall will also be three times sharp i.e. 30 per cent. Can you assess that high Beta means that the share is very volatile, i.e. more risky? Beta seems to be a great way to measure the risk of any stock. If you look at young, technology stocks, they will always carry high betas. Many utilities, on the other hand, carry Betas below 1. If, during the bull phase of the market, you come across an analysis in an investment magazine (like Dalal Street Investment Journal ) wherein they have given the Beta value of a share, you may invest in that share only if the Beta value is high. But do not buy that share if the overall market sentiment is low. If the Beta value is less then 1, such shares cannot give high returns in a rising market but will add to your confidence in a falling market. Investors can find the best use of the Beta ratio in short term decision-making wherein price volatility is important. If you are planning to buy and sell within a short period, Beta is a good measure of risk. However, as a single predictor of risk for a long-term investor, the Beta has too many flaws. Careful consideration of a company’s fundamentals will give you a much better picture of the potential long-term risk.


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