When analyzing a stock, what does "beta (three year monthly)" mean?
Is this information valuable when choosing between different funds in the same category?
Beta is a measure of volatility. It is essentially a comparison of one investment to a standardized index. If the number is greater than 1, then the investment was more volatile than the index. If it is less than 1, then it has been less volatile than the index. If it was 1.10, then it was 10% more volatile than the index, at .91 is was (roughly) 10% less than the index. It's important to know several things: what index is being used? If you compare the movements of a single stock against the S&P500 index, the Beta math might be correct, but how good is a comparison of one stock to 500 stocks? Similarly, it wouldn't make much sense to compare a bond mutual fund volatility to an S&P500 index ... they are vastly different investments. Make sure you understand the index used and calculate a different Beta using a different index if that makes more sense. Another issue is the time frame. A "three year monthly" Beta compares just three years of data. That same calculation could be done with five years or ten years, and might be more or less accurate for understanding. You didn't ask this, but volatility is the usual measure of risk in portfolio science. If an investment is more risky (more volatile), investors expect higher returns. Less risky investments generally provide lower returns. Beta is also used to measure portfolio returns with a general rule that a 10 percent higher Beta (volatility) should yield a 10 percent higher return ... Alpha is the statistic (+ or -) that compares actual returns using Beta.
Beta is a measure of risk. For instance, the S&P 500 has a beta of 1 and when comparing a corresponding investment that also has a beta of 1 that means they technically have the same risk characteristics and you would expect the same type of volatility. If the underlining investment has a beta .2 that means it has 20% of the comparable risk and if the market went up 10% you would expect that investment to go up 2% and vice versa in a down market. If it has a beta of .9 that means it has 90% of the risk and 90% of the expected returns on the up and the down. If data is available for R2, that is also worthwhile when comparing metrics to an index. R2 of 100 means a direct fit. R2 of 50 means half the time the data sets may correspond making a comparison rather meaningless.
You are asking a good question. Essentially, it is the way a fund or a stock moves based on the overall market. The information can be valuable if you know how you are trying to invest and what you are trying to accomplish. If you want to own a fund that moves opposite the direction of the market, you would not want a high beta. Here is the definition that investopedia provides- I hope this helps answer your question.
Beta, also known as the "beta coefficient," is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is calculated using regression analysis, and you can think of it as the tendency of an investment's return to respond to movements in the market. By definition, the market has a beta of 1.0. Individual security and portfolio values are measured according to how they deviate from the market.
A beta of 1.0 indicates that the investment's price will move in lock-step with the market. A beta of less than 1.0 indicates that the investment will be less volatile than the market. Correspondingly, a beta of more than 1.0 indicates that the investment's price will be more volatile than the market. For example, if a fund portfolio's beta is 1.2, it's theoretically 20% more volatile than the market.
Conservative investors looking to preserve capital should focus on securities and fund portfolios with low betas, while those investors willing to take on more risk in search of higher returns should look for high beta investments.
Yale Bock, CFA
Y H& C Investments
Beta is a statistical measure of volatility. It's the ratio of the volatility of your fund, as measured by its standard deviation of returns, to the volatility of the market as measured the same way. A beta of 1.00 means the fund is exactly as volatile as the market.
You measure standard deviation by using the mean (in the case of investments, the long term average return) and taking the sum of the squares of the difference between each period return and the mean. You use squares in order to eliminate offsetting the positive deviations with negative ones. The standard deviation is the square root of that number. Are you sufficiently confused now?
When we refer to "risk" in investing, we really mean the volatility. That is, what is the probability that something unexpected might happen? (Remember that it's equally likely that an "unexpected" return would be better than average as it would be to be worse.) In general, risk and return are related and a fund that has a high historical return might have achieved it by taking higher-than-average risk. That's why beta is included in a fund-analysis. (By the way, in your question you switch from "analyzing a stock" to "choosing ... funds." I think beta is a little more useful for analyzing funds than it is for analyzing stocks, but I don't think highly of it as a guide to selecting anything. I say that because it's an historical measure, backward-looking. If your stock had a period of volatility last year around a unique event that is unlikely to recur, it would have a high historical beta. But this would be no indicator of its future volatility.
In addition, I would mention that a low-beta portfolio might be so boring that you would never make money. The point is not to avoid risk at any cost; the point is to manage it sensibly. There are lots of high-volatility stocks of companies that are in relatively low-risk businesses. Focus on the company you want to invest in, and select companies that are well-managed, financially sound, innovative, with a sustainable competitive advantage, and reasonably priced in the market (or bought when the market is down). Good luck.
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Beta is a measure of a stock's volatility in relation to the market. By definition, the market has a beta of 1.0, and individual stocks are ranked according to how much they deviate from the market. A stock that swings more than the market over time has a betaabove 1.0.
Brett M. Sause, LUTCF®, LTCP®, CLTC®, RFC®, LACP®, FSCP®
Principal & CEO