What is Beta?
A riskier investment means that the investor demands to be compensated with a higher return.
Beta is a measurement of risk.
It is a measurement of how volatile a stock or industry is compared to the entire market itself.
How is this done?
A beta of 1.0 means the stock/industry will follow the market. If the SnP500 rises 2% then my stock with a beta of 1.0 will also rise approximately 2%.
If my stock has a beta of 1.5, it is theoretically 50% more volatile than the market. If the silver industry’s beta is 0.5, than it is 50% less volatile than the entire market.
How to use beta?
Compare the beta of a stock to its industry and competitors. By doing this the investor can determine how volatile a stock is and if it is worth the potential payoff.
For example, Amazon (AMZN) has a beta of 1.72. This means that it is theoretically 72% more volatile than the market. Note that the 1.72 beta doesn’t mean anything until the investor compares it with amazon’s industry and its competitors.
The online retail industry of 61 firms has a beta of 1.12. This means that amazon is a lot more volatile than the industry average.
Amazon’s competitor eBay Inc. (EBAY) has a beta of 1.51. This means that amazon’s beta of 1.72 is not too much riskier than its competitor.
Beta is only one factor out of many that can affect a investor’s stock valuation. The reason Amazon might have a higher beta is because it is doing more with its money now so that it will have a bigger market share and be more competitive in the future.
Beta is a simple single factor that an investor can skim to determine a stock’s volatility to its competitors, industry, and the entire market itself.
If you are curious, read more into beta at https://www.investopedia.com/terms/b/beta.asp
