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Everything You Need to Know About High Beta Stocks

12 Mins 01 Jun 2023 0 COMMENT

Introduction

The Indian stock market is rife with diverse investment opportunities, one of them being high-beta stocks. These are stocks that display higher-than-market volatility, which means that their risk-reward, as well as the risk-loss ratio, is also considerably higher than other stocks. Investments in high-beta stocks require careful consideration, which is why we will delve into further detail as we go along.

What is beta in high beta stocks?

Beta (β) measures the volatility of a stock relative to the broader market. The Indian market is represented by benchmark indices such as NSE Nifty50 and BSE SENSEX. In simpler terms, beta measures how much a stock’s price will move when the market index moves.

The market indices have a beta value of 1. So, if a stock has a beta value higher than 1, it means that the stock is moving more than the market index. For example, if a stock has a beta value of 1.2 and Nifty moves by 10%, then the stock will move by 12% (1.2 x 10).

Similarly, a beta less than 1 means it moves lesser than the market index. So, if a stock has a beta of 0.8 and Nifty moves by 10%, the stock moves by 8% (0.8 x 10).

If the beta of a stock is 1, then it exactly mirrors the index movement.

So, what are high beta stocks? High-beta stocks are those with a beta greater than 1, implying that they show a great degree of price movement – upward or downward. They are therefore high-risk investments with high volatility. However, the higher volatility makes them attractive to investors who are looking to make faster gains than the broader market in a short period of time.

Investing in High-Beta Stocks

Since these call for a high risk-appetite, what do high-beta stocks mean for investors? Investors in such stocks need to get comfortable with a high degree of price movement. Such price swings are not limited to a bullish market and can therefore be very damaging in a bearish market. This nature of high-beta stocks makes it essential for investors to have a solid understanding of the company’s fundamentals including its future outlook.

Nonetheless, there is a way to tackle the risks associated with high-beta investments – diversification. While the systematic risk is unavoidable in a single-stock investment, it can be offset by investments in low-beta stocks. This is also called ‘risk hedging.’

A second strategy can be to invest in undervalued high-beta stocks. This involves the evaluation of metrics such as the price-to-earnings ratio (P/E) in comparison to other peer companies in the same segment. One should note that multiple metrics should be used in deciphering whether a company is undervalued or not as relying on just one could prove to be dangerous.

Examples of High-Beta Stocks

In India, there are several high beta stocks belonging to various sectors. Some of these include (Beta values mentioned here are at the time of writing):

  • Tata Motors (TATAMOTORS): With a beta of 1.77, Tata Motors is a high beta stock that operates in the automotive industry.
  • Vedanta (VEDL): Vedanta is a high beta stock with a beta of 1.57. The company operates in the natural resources sector, specifically metals and mining.
  • Indiabulls Housing Finance (IBULHSGFIN): Indiabulls Housing Finance is a high beta stock with a beta of 1.85. The company provides housing finance and loans in India.
  • Yes Bank (YESBANK): The private sector lender Yes Bank has a beta of 1.68.

These high-beta stocks are represented by the Nifty High Beta 50 Index, which tracks 50 such companies on the NSE. Here is the sectoral weightage in the index (Source: NSE Factsheet as on 15th March 2023):

 

Limitations and Risks of High-Beta Stocks

While high beta stocks offer the potential for larger returns, they also come with a higher level of risk. As an investor, you stand to lose just as much as you stand to gain. This means that high-beta investments are more suited to a bullish market. Since high-beta stocks are more sensitive to changes in the broader market, a downturn in the overall market can hit high-beta stocks particularly hard.

Additionally, beta is a responsive metric, which means that it does not factor in new information. It only shows how much a stock will respond to an index’s movement. And when investors consider risk, they typically look at the downside of investing in a stock. Since beta does not indicate whether the stock’s price movement will be upward or downward, it does not help high-beta investors make an assessment. Hence high beta stocks cannot be evaluated solely on the basis of their beta value and demand extra caution.

Finally, it’s important to note that high beta stocks are not suitable for all investors. Investors who are risk-averse or who are investing for the long-term may be better served by other types of stocks or assets.

What Does a High Beta Tell Investors?

Investment decisions change from investor to investor. A stock with a beta greater than 1 simply signals to an investor the degree to which the price of that particular stock will move when the market index moves by a certain amount. Although the high beta also signals the involvement of higher risk in the trade, it is helpful in indicating the extent to which gains or losses can be made from the underlying stock’s price movement.

How does beta measure risk?

Since beta is a measure of the volatility of a single stock, it is also a measure of ‘systematic risk’ which cannot be mitigated. It is an inherent risk in the market whose movements are caused by economic and geopolitical factors, which makes volatility unavoidable.

However, comparing the beta of various stocks can help risk-averse investors understand which stock is more suited to their investment style and can thus aid in making decisions.

For high-risk investors, this means that they can check beta values to filter out sluggishly moving stocks to focus on volatile stocks for short-term gains.

Conclusion

High-beta stocks seem lucrative when one only looks at the potential upside. They must bear in mind that market downturns can be equally catastrophic in terms of losses. It is worth reiterating that in-depth analysis must precede any kind of investment in a high-beta stock. After all, precaution is better than cure.

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