Definition

Beta is a calculation that compares a stock’s historical performance against the overall performance of the entire stock market. This quantifies the stock’s relative volatility. Volatility is a measure of how much prices change during fluctuation. All stocks fluctuate, but for some the price swings are much more significant. Beta corresponds to the stock’s volatility as a multiple of the overall market. A beta of 1 implies volatility that is approximately the same as the overall market. A beta of 2 suggests the stock is twice as volatile while a beta of 0.5 implies the stock is half as volatile.

Risk

Risk generally increases with beta. A high-beta stock is not appropriate for investors who seek relatively tame stocks. However, the potential rewards match the risk. For investors willing to accept large potential losses, a high beta stock can be lucrative if it performs well. During times of high overall stock market volatility, conservative investors may prefer stocks with betas that are less than 1, which should be less volatile than the overall market.

Lagging Indicator

Beta is calculated based on historical performance of a stock. It is obviously not possible to include data from prices that have not yet occurred. Such indicators are lagging since they are entirely based on past information. Thus the beta indicator is not a guarantee that volatility will behave as the calculations suggest. A stock’s volatility can change with time and the beta may also change values along with price.

Corporate Events

References

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