The topic of this article is the answer to the following question: why is it important to know the beta of a stock?
The beta of a stock has to do with the volatility of a stock.The volatility of a stock is essentially the risk of a stock.Is the value of the stock going to swing about wildly?Is it going to drop suddenly?Is it going to stay basically stable?What is the variability of a stock when compared to the overall stock market?
Some theorists believe that it is important for investors to know the risk of a stock when deciding whether or not to invest in that particular stock.To that particular end, there have been several mathematical models developed to help determine the risk of a stock.The mathematicians and the economists who have developed these models use complex mathematical and statistical procedures to determine the risk of a stock when compared to the overall market.One of the most popular tools of measurement is called beta.
The beta measurement of a stock compares the variability of the value of a stock in the past compared to the overall stock market.If the beta of a stock is close to one, this means that the value of a stock moves up and down at basically the same rate as the overall stock market.So if the stock market rises 2% and a stock has a beta of 1, then the stock will probably rise in value about 2% also.Similarly, if the market drops about 4% on a particular day, then the stock with a beta of 1 will drop about 1%.
If a stock has a beta measurement of more than 1, then its value moves up and down more dramatically than the overall stock market.If the stock market rises, then a stock with a beta measurement of 2 will probably rise an amount double to the stock market.If the stock market rises 3%, then the stock will probably rise 6%, giving you a high yield on that stock.But remember that if the stock market drops 3%, then the particular individual stock with a beta measurement of 2 will drop 6%, and you will be losing a fair amount of money on that stock.Stocks with high beta measurements are a riskier investment.However, they can also give you a higher return on your investment in the short term.
Stocks with a beta measurement of less than one, say 0.5 to make it easy, will rise and fall at a lower rate than the overall stock market.If the stock market rises 4% in one day, then this stock will only rise 2%.But the good news on this stock is that if the stock market drops 10% in one day, your stock will only drop 5%.Stocks with a low beta measurement are more stable, and are “safer” if you are worried about losing a lot of money on your investment.
So should you be worried and interested in the beta measurement of your stock?Well, it depends on what kind of investor you are.Beta measurement only takes into consideration the past history of a stock.It does not take into account any new developments of a company.It can tell you how a stock acted in the past, but it is not necessarily an accurate measurement of how a stock will perform in the future.If you are interested in short term, high yield investments, then it is important for you to know the beta measurement so that you can find stocks with a higher beta than 1, which will give you a higher short term return on your investment.If you are a long term investor, or a value investor, then beta measurements are not as important to you.They will probably not give you an accurate measurement of how a stock will perform in the long term future, and so you should look at other stock and company fundamentals than beta measurement.