What does a beta really tell you about a stock?
A beta is a measure of the market risk of investing in a stock. It aids investors in picking stocks that meet their risk requirements.
But have you ever noticed that different Web sites often report different betas for the same stock? How does that work?
The beta is basically a score that measures a stock's risk against the rest of the market. Betas are calculated using regression analysis. The market -- usually the S&P 500 -- is given a beta of 1. If the stock is more volatile than the market, the stock's beta will be greater than 1. If it is less volatile than the market, the beta will be less than one.
For example, a stock with a beta of 0.4 would be expected to return 40% as much as the overall market. A stock with a beta of 1.5 would move 50% more than the overall market.
However, there are more than one way to calculate betas. This is why there are different betas on different Web sites for the same stock. One of the variables in calculating betas is how far back you go with the calculation. Some calculations look at three years of data, while others look at five years.
What does the beta tell you? It doesn't tell you if the beta will be more or less next year. The calculations look to the past, not to the future. It will not predict the future of the stock.
The beta tells you how the stock has historically reacted to market-wide or systemic conditions. However, you will not find any information in the beta in regards to the company's strengths or weaknesses within its industry. For example, the beta will tell you how a stock will react compared to the whole market when a change in interest rates occurs. But it will not tell you anything about the effect of legislation on the importation of a product, which could have a strong impact on several businesses or one specific industry.
Betas are helpful in determining the likelihood of price swings, but are not indicative of the entire picture. Make sure that you find a financial source that you like and use it's betas every time. This will ensure that you are comparing the same type of betas each time.
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