What is mean by beta stocks?

What is beta?

Beta is a measure of systematic risk, a risk that cannot be avoided by diversifying one’s portfolio. In simple terms, it measures the volatility of a stock’s returns in comparison to the market. Beta is used to calculate a stock’s expected return in the widely followed capital asset pricing model (CAPM).

E(R) = RFR + β*ERP

where E(R) = expected returns of a stock

RFR = Risk free rate (for example, government/sovereign bonds)

β – beta

ERP – expected risk premium calculated as expected returns on market – risk free rate

For ease, the beta for NSE stocks is measured relative to a index.

Why is beta measure important?

Beta measure is significant because it tells you how a stock’s returns are commensurate with the market especially in a highly volatile period such as the period after August 2011, . High beta stocks fall rapidly during market decline and gain more than the market during a rally. High risk, high returns is the premise.

β = covariance of a stock’s returns relative to market returns/ variance of market

Covariance is a statistical measure that defines the movement of two variables.  It can take any value from -ve  inifinity to +ve infinity; the number by itself doesn’t convey anything.

What does a beta value of 1.3 or 0.8 mean?

A stock’s beta of 1.3 implies the stock is 30% more volatile than the market or index it is compared against. Commodity and banking stocks usually have a higher beta whereas defensive stocks have a beta lesser than 1. A beta of 0.8 indicates the stock is 20%  lesser volatile than the market.

How is beta computed?

Beta is calculated using regression analysis (some hi-fi stuff that we’ll not get into). But, if you’re really interested on knowing more about linear regression analysis, check these out.

Beta values of Nifty stocks – NSE

Note : When you analyse the returns of the all the stocks (including the low beta ones) over the same period, it is safe to conclude that returns of a good percentage of high beta stocks have exceeded market returns; and low beta stocks have under performed the index.