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In this series, we break down the jargon and explain a popular investing term or topic. It’s high beta here.
It sounds like a healthy food, but I dare say it is not.
You would be right. A stock’s beta is a measure of its volatility relative to a stock index, such as the FTSE 100 or the US S&P 500.
As a point of reference, the index has a beta of 1. If a stock’s ups and downs are less than those of the index, it will have a beta less than 1.
But if its turns are greater than those of the index, its beta will be greater than 1 and will be considered high.
A stock with a beta of 2 should outperform the broader market when the index is rising, but does worse than other stocks when the trend is down.
Taking risks: If you have strong nerves, high beta stocks could be for you, as long as you can intelligently time when you buy and when you sell.
It is interesting to look at the beta scores for the FTSE 100. Ocado has a beta of 3.55, while AstraZeneca’s beta is 0.55.
What is the message of this?
If you have strong nerves, high-beta stocks could be for you, as long as you can intelligently time when you buy and when you sell. But don’t expect this strategy to work. Before buying a high beta stock, you need to be sure that the potential rise in the stock price is worth the risk.
Why is that?
Surprisingly, stocks with lower beta have historically offered higher returns than those with higher betas.
This phenomenon, first observed about 50 years ago, and examined incessantly since then by economists and stock market analysts, is called the “low beta anomaly” or “low beta premium.”
There has been a great deal of “deep” research into the reasons why low beta or “low volume” stocks offer better returns. Some argue that it arises from the way fund managers select stocks, which can be subject to various types of biases. There may also be an element of overconfidence in the prospects of high beta stocks.
Why do we read about this?
More attention is being paid to high betas amid speculation about the next moves in the stocks of the Magnificent Seven tech titans.
The Mag 7’s soaring prices have delighted investors, but recent declines have caused consternation, although these declines were short-lived.
Microsoft has a beta of 0.88, while Alphabet, which owns Google, has a beta of 1.03. The other scores are Amazon – 1.15, Apple 1.27, Meta – 1.17 and Nvida – 1.76. Tesla’s beta is 2.47. This is a strong indication that there may be steeper swings ahead for the electric car maker, which may be one of the reasons why most analysts rate Tesla a “hold” rather than a “buy.”