Stock traders and investors can benefit greatly from understanding the metrics to evaluate a stock. The issue is that many of these measurements can be difficult to grasp or even impossible.

Stocks' beta values fall into this group. So you're in the right place if you're looking for a brief explanation of beta value. Please follow along as we explain what Beta is and how to calculate it.

What does the stock market's Beta mean?

A mathematical concept known as beta gauges a stock's level of risk in relation to the market as a whole. The beta value may be positive or negative depending on the stock under consideration. Additionally, the market's beta value is always 1.

A stock is considered to be very volatile if its beta value is high (>1). Conversely, a stock with a low Beta (1) is considered more stable and less erratic than the market. Not only that.

The beta number may also serve as a proxy for a stock's potential for profit.

While low-beta companies will likely produce returns that are more or less in order with the market, high-beta stocks have the potential to create huge returns (or lower). It's easy to understand why the market has a beta of 1.

Beta measures a stock or asset's movement concerning the market. What influences how the market moves? Itself. There is one more thing you should be aware of.

You must contrast a stock with the appropriate benchmark index to determine its beta value.

How is the Beta of a stock calculated?

Beta is a mathematical measure. Hence there is a formula to calculate it in the end. For example, you may get a stock's Beta by following these steps:

· Calculate the stock and market returns' product of covariance.

· Determine the market's return variance** (for a set time)

· To determine the stock's beta value, divide #1 by #2.

· The formula for calculating a stock's Beta looks like this:

  • Beta () is equal to Cov (Ri, Rm)/Variance (Rm)
  • Ri: Stock return formula
  • Rm is the overall market return.

Ø Covariance: a measurement of the peaks and troughs in a stock's returns relative to those of the market

Ø Variance: the difference between the returns of the market and its average

Different Beta Values

Four categories can be used to classify this roughly:

  • The beta value is less than 1.0. : The stock should be less volatile than the market. With a stock like this in it, an investor's portfolio might be less hazardous than it would be without it.
  • A stock with a beta of 1.0: theoretically has the same characteristics as the market. Adding this stock to a portfolio may have no effect on risk.
  • Stock's beta value exceeds 1.0: it could be more volatile than the market. By including such stock in your portfolio, your risk may dramatically increase.
  • A stock with a negative beta: theoretically has an inverse link to the market. The stock may decline if the market rises, and vice versa.

FINAL INSIGHT

Conclusively, a stock's low Beta value does not guarantee that it will be a wise investment. For example, a stock that is less erratic than the market may experience a protracted downward trend.

Using the beta value, you may estimate a stock's price movement concerning its benchmark index. Theoretically, being aware of the rewards and risks related to a stock can be helpful.