What is Beta?
Beta (β) measures how much an individual security’s price fluctuates in relation to the broader market. Analysts use the Beta Coefficient to determine the volatility and risk of a stock or another security relative to the overall market.
Stocks whose prices move generally in the same direction as the stock market will have positive β. Stocks whose prices move in the opposite direction as the stock market will have negative β. Gold and gold stocks, for example, have a negative Beta Coefficient. Investors view gold as a “safe haven” that stores value. When the stock market declines, investors take money out of stocks and invest in gold. As a result, when stock prices decline, gold prices often increase due to the increased demand.
The stock market has a standard Beta of 1.0. Individual stocks will have Betas higher or lower than 1.0, based on their volatility relative to the stock market as a whole. Stock whose prices move to a greater extent than the stock market have β higher than 1.0. These stocks are more volatile than the overall market. Stocks whose prices move to a lesser extent than the stock market have β lower than 1.0. These stocks are less volatile than the overall market.
In short, Beta can be either positive or negative. It can also be higher or lower than 1.0.
Measure of Risk
Financial analysts use Beta as a measure of a stock’s risk. Volatility indicates risk. The higher the β, the higher the risk. Likewise, the lower the coefficient, the lower the risk. In other words, Beta is a measure of the stock’s risk profile relative to the broader stock market. A β higher than 1.0 is more risky than the stock market. A β lower than 1.0 is less risky than the stock market.
This concept of the coefficient is an important component of the Capital Asset Pricing Model (CAPM). CAPM uses this metric to calculate Cost of Equity, which flows into the Discounted Cash Flow analysis.