Beta
When Investing: Beta is a measure of the return from a portfolio that comes right from the market. It doesn't involve investor skills (alpha), and is the return that you should expect if you invest in an index fund such as an ETF exchange traded funds.
Table of Contents
Beta Coefficient
Beta measures risk. It tells you how closely the expected returns are to the S&P index. A beta of 1.0 means that 10% increase in the market should result in a 10% increase in the stock (or investment project). If the beta is >1.0 , then its more risky than the S&P 500, and should have a higher return. If the beta is less than 1.0, then the stock is less responsive to market movements than the average, and is therefore considered less risky, and should have a lower expected return.
For example, if every stock in the New York Stock Exchange was uncorrelated with every other stock, then every stock would have a Beta of zero, and it would be possible to create a portfolio that was nearly risk free, simply by diversifying it sufficiently so that the variations in the individual stocks' prices averaged out. This would be like owning a casino: essentially none of the business risk of owning a casino comes from the uncertain outcomes of the games of chance played by the customers, because those are uncorrelated, and average out over any significant period of time. In reality, investments tend to be correlated, more so within an industry, or when considering a single asset class (such as equities), as was demonstrated in the Wall Street crash of 1929. This correlated risk, measured by Beta, is what actually creates almost all of the risk in a diversified portfolio.
The formula for the Beta of an asset within a portfolio is
The Beta coefficient, in terms of finance and investing, is a measure of a stock (or portfolio)’s volatility in relation to the rest of the market. Beta is calculated for individual companies using regression analysis. The beta coefficient is a key parameter in the capital asset pricing model ( CAPM). It measures the part of the asset's statistical variance that cannot be mitigated by the diversification provided by the portfolio of many risky assets, because it is correlated with the return of the other assets that are in the portfolio.
Definition from wikipedia
Problems with using beta
Using historical estimates of beta to calculate hurdle rates is made more difficult if the company has multiple lines of business. It would then be the weighted average of the various betas of the different lines of business.
Another problem is that leverage affects beta. Adding debt to a firm will increase its equity beta even if teh riskiness of the firms assets remains unchanged. As debt increases, the cash flows to remaining shockholders becomes more risky. The historical beta of a firm, therefore, has to be adjusted unless the new project has exactly the same risk and same leverage as the firm.
Industry Name |
Number of Firms |
Average Beta |
Market D/E Ratio |
Tax Rate |
Unlevered Beta |
Cash/Firm Value |
Unlevered Beta corrected for cash |
Advertising |
36 |
0.99 |
22.25% |
11.96% |
0.83 |
6.85% |
0.89 |
Aerospace/Defense |
73 |
0.92 |
20.81% |
21.77% |
0.79 |
6.35% |
0.84 |
Air Transport |
56 |
1.38 |
42.16% |
19.40% |
1.03 |
11.95% |
1.17 |
Apparel |
64 |
0.93 |
13.39% |
21.60% |
0.84 |
5.46% |
0.89 |
Auto & Truck |
31 |
1.29 |
125.80% |
18.90% |
0.64 |
11.63% |
0.72 |
Auto Parts |
64 |
0.99 |
52.49% |
18.93% |
0.69 |
9.69% |
0.77 |
Bank |
550 |
0.59 |
54.59% |
27.81% |
0.43 |
10.20% |
0.47 |
Bank (Canadian) |
7 |
0.72 |
10.07% |
24.41% |
0.67 |
4.78% |
0.70 |
Bank (Foreign) |
4 |
1.78 |
NA |
0.00% |
NA |
NA |
NA |
Bank (Midwest) |
37 |
0.79 |
61.47% |
29.14% |
0.55 |
8.86% |
0.61 |
Beverage (Alcoholic) |
27 |
0.66 |
23.56% |
15.30% |
0.55 |
1.67% |
0.56 |
Beverage (Soft Drink) |
21 |
0.71 |
13.63% |
17.74% |
0.63 |
3.75% |
0.66 |
Biotechnology |
105 |
1.56 |
4.39% |
4.41% |
1.50 |
6.65% |
1.61 |
Building Materials |
47 |
0.98 |
33.54% |
23.55% |
0.78 |
14.48% |
0.91 |
Cable TV |
23 |
1.76 |
38.89% |
13.90% |
1.31 |
2.42% |
1.35 |
Canadian Energy |
14 |
0.73 |
14.27% |
30.19% |
0.66 |
1.28% |
0.67 |
Cement & Aggregates |
13 |
1.02 |
26.35% |
26.29% |
0.85 |
2.61% |
0.87 |
Chemical (Basic) |
24 |
0.98 |
27.64% |
13.31% |
0.79 |
5.08% |
0.83 |
Chemical (Diversified) |
36 |
0.97 |
16.32% |
25.87% |
0.86 |
3.74% |
0.90 |
Chemical (Specialty) |
94 |
0.98 |
21.54% |
19.08% |
0.84 |
3.25% |
0.87 |
Coal |
16 |
1.75 |
15.96% |
11.64% |
1.53 |
4.11% |
1.60 |
Computer Software/Svcs |
425 |
1.84 |
3.56% |
10.36% |
1.79 |
10.49% |
2.00 |
Computers/Peripherals |
148 |
1.99 |
6.68% |
7.84% |
1.88 |
12.11% |
2.14 |
Diversified Co. |
134 |
0.87 |
22.60% |
18.87% |
0.74 |
5.95% |
0.79 |
Drug |
334 |
1.59 |
9.36% |
6.09% |
1.46 |
8.53% |
1.60 |
E-Commerce |
60 |
2.23 |
3.86% |
9.38% |
2.15 |
14.00% |
2.50 |
Educational Services |
37 |
1.09 |
2.65% |
20.95% |
1.06 |
8.99% |
1.17 |
Electric Util. (Central) |
24 |
0.94 |
69.87% |
26.93% |
0.62 |
1.66% |
0.63 |
Electric Utility (East) |
29 |
0.87 |
56.29% |
28.01% |
0.62 |
1.26% |
0.63 |
Electric Utility (West) |
16 |
0.97 |
58.80% |
28.87% |
0.68 |
3.26% |
0.71 |
Electrical Equipment |
94 |
1.52 |
72.60% |
15.47% |
0.94 |
7.73% |
1.02 |
Electronics |
186 |
1.49 |
14.54% |
13.04% |
1.33 |
14.11% |
1.54 |
Entertainment |
101 |
1.30 |
26.12% |
16.69% |
1.07 |
4.53% |
1.12 |
Entertainment Tech |
31 |
2.18 |
3.38% |
10.21% |
2.12 |
16.90% |
2.55 |
Environmental |
96 |
0.87 |
48.22% |
9.45% |
0.60 |
2.14% |
0.62 |
Financial Svcs. (Div.) |
269 |
0.89 |
132.40% |
19.72% |
0.43 |
6.92% |
0.47 |
Food Processing |
123 |
0.72 |
22.39% |
19.60% |
0.61 |
2.53% |
0.63 |
Food Wholesalers |
21 |
0.72 |
29.15% |
23.66% |
0.59 |
5.02% |
0.62 |
Foreign Electronics |
10 |
1.03 |
23.76% |
41.66% |
0.90 |
15.59% |
1.07 |
Furn/Home Furnishings |
38 |
0.87 |
30.22% |
26.93% |
0.71 |
4.45% |
0.75 |
Grocery |
19 |
1.04 |
39.11% |
23.54% |
0.80 |
5.43% |
0.84 |
Healthcare Information |
34 |
1.22 |
10.30% |
10.07% |
1.12 |
8.50% |
1.22 |
Home Appliance |
14 |
0.84 |
18.39% |
14.69% |
0.73 |
11.22% |
0.82 |
Homebuilding |
41 |
0.98 |
61.74% |
23.77% |
0.67 |
5.51% |
0.71 |
Hotel/Gaming |
84 |
0.77 |
33.19% |
14.22% |
0.60 |
2.99% |
0.62 |
Household Products |
31 |
0.79 |
18.46% |
24.86% |
0.69 |
2.74% |
0.71 |
Human Resources |
35 |
1.22 |
7.87% |
25.27% |
1.15 |
8.29% |
1.26 |
Industrial Services |
230 |
1.01 |
19.71% |
16.91% |
0.86 |
6.02% |
0.92 |
Information Services |
41 |
1.02 |
8.15% |
18.42% |
0.95 |
3.80% |
0.99 |
Insurance (Life) |
40 |
0.93 |
13.15% |
23.66% |
0.85 |
13.06% |
0.98 |
Insurance (Prop/Cas.) |
97 |
0.83 |
12.40% |
18.73% |
0.75 |
14.33% |
0.88 |
Internet |
329 |
2.30 |
2.28% |
4.76% |
2.25 |
8.55% |
2.46 |
Investment Co. |
20 |
0.75 |
103.83% |
0.00% |
0.37 |
5.64% |
0.39 |
Investment Co.(Foreign) |
15 |
1.21 |
4.09% |
2.49% |
1.16 |
2.53% |
1.19 |
Machinery |
139 |
1.01 |
31.26% |
20.52% |
0.81 |
4.62% |
0.84 |
Manuf. Housing/RV |
19 |
0.99 |
19.00% |
19.77% |
0.86 |
11.03% |
0.96 |
Maritime |
46 |
0.86 |
60.09% |
5.91% |
0.55 |
4.39% |
0.58 |
Medical Services |
186 |
0.94 |
17.47% |
17.17% |
0.82 |
11.80% |
0.93 |
Medical Supplies |
279 |
1.11 |
6.47% |
13.16% |
1.05 |
6.74% |
1.12 |
Metal Fabricating |
37 |
1.01 |
15.88% |
24.89% |
0.91 |
3.46% |
0.94 |
Metals & Mining (Div.) |
82 |
1.04 |
8.74% |
7.81% |
0.96 |
3.22% |
0.99 |
Natural Gas (Distrib.) |
30 |
0.73 |
60.93% |
30.18% |
0.51 |
2.60% |
0.52 |
Natural Gas (Div.) |
34 |
1.01 |
40.33% |
22.04% |
0.77 |
3.91% |
0.80 |
Newspaper |
18 |
0.76 |
30.08% |
24.85% |
0.62 |
1.53% |
0.63 |
Office Equip/Supplies |
26 |
1.02 |
24.34% |
29.99% |
0.87 |
6.01% |
0.93 |
Oilfield Svcs/Equip. |
110 |
1.05 |
11.72% |
21.42% |
0.96 |
4.33% |
1.01 |
Packaging & Container |
36 |
0.87 |
55.22% |
25.40% |
0.61 |
3.60% |
0.64 |
Paper/Forest Products |
42 |
0.84 |
56.50% |
15.72% |
0.57 |
5.38% |
0.60 |
Petroleum (Integrated) |
30 |
0.96 |
9.00% |
29.47% |
0.90 |
5.16% |
0.95 |
Petroleum (Producing) |
178 |
0.88 |
13.69% |
14.79% |
0.79 |
1.71% |
0.80 |
Pharmacy Services |
20 |
0.93 |
9.04% |
27.16% |
0.88 |
3.59% |
0.91 |
Power |
41 |
2.39 |
17.83% |
6.84% |
2.05 |
1.76% |
2.08 |
Precious Metals |
67 |
0.90 |
7.10% |
6.54% |
0.84 |
4.65% |
0.88 |
Precision Instrument |
104 |
1.71 |
8.97% |
17.07% |
1.59 |
13.52% |
1.84 |
Publishing |
50 |
0.89 |
32.54% |
18.02% |
0.70 |
3.76% |
0.73 |
R.E.I.T. |
143 |
0.77 |
63.99% |
1.41% |
0.47 |
4.65% |
0.50 |
Railroad |
20 |
0.96 |
29.86% |
23.61% |
0.78 |
1.98% |
0.79 |
Recreation |
84 |
1.12 |
20.04% |
18.03% |
0.96 |
4.94% |
1.01 |
Restaurant |
81 |
0.80 |
15.21% |
19.13% |
0.71 |
4.14% |
0.74 |
Retail (Special Lines) |
164 |
0.98 |
8.43% |
23.42% |
0.92 |
9.15% |
1.02 |
Retail Automotive |
15 |
1.04 |
34.98% |
34.85% |
0.84 |
4.60% |
0.89 |
Retail Building Supply |
9 |
0.95 |
5.82% |
27.35% |
0.91 |
1.26% |
0.92 |
Retail Store |
51 |
0.94 |
16.61% |
21.10% |
0.83 |
4.47% |
0.87 |
Securities Brokerage |
32 |
1.29 |
155.35% |
21.27% |
0.58 |
25.89% |
0.78 |
Semiconductor |
124 |
2.92 |
4.97% |
10.47% |
2.79 |
12.37% |
3.19 |
Semiconductor Equip |
14 |
2.95 |
7.53% |
21.31% |
2.78 |
18.08% |
3.40 |
Shoe |
24 |
1.08 |
3.64% |
28.93% |
1.05 |
8.36% |
1.15 |
Steel (General) |
30 |
1.16 |
14.62% |
29.85% |
1.05 |
7.35% |
1.13 |
Steel (Integrated) |
16 |
1.50 |
23.62% |
18.09% |
1.26 |
9.77% |
1.39 |
Telecom. Equipment |
136 |
2.35 |
5.28% |
10.38% |
2.24 |
14.60% |
2.63 |
Telecom. Services |
173 |
1.43 |
32.64% |
12.90% |
1.11 |
3.55% |
1.15 |
Thrift |
248 |
0.56 |
22.62% |
25.14% |
0.48 |
11.25% |
0.54 |
Tire & Rubber |
10 |
0.96 |
14.18% |
5.94% |
0.85 |
6.11% |
0.90 |
Tobacco |
11 |
0.79 |
17.06% |
26.74% |
0.70 |
4.02% |
0.73 |
Toiletries/Cosmetics |
21 |
0.83 |
18.06% |
20.95% |
0.72 |
4.94% |
0.76 |
Trucking |
38 |
0.98 |
40.58% |
30.50% |
0.77 |
5.40% |
0.81 |
Utility (Foreign) |
6 |
1.00 |
62.76% |
11.52% |
0.64 |
3.70% |
0.67 |
Water Utility |
16 |
0.73 |
48.86% |
29.78% |
0.54 |
0.70% |
0.54 |
Wireless Networking |
73 |
2.41 |
17.70% |
9.93% |
2.08 |
6.50% |
2.22 |
Other |
1 |
1.06 |
2.45% |
0.00% |
1.03 |
1.44% |
1.05 |
Market |
7661 |
1.14 |
32.11% |
16.40% |
0.90 |
7.53% |
0.98 |
How to value Stocks:
One have to consider a whole slew of factors before making a stock purchase. For the beginning investor, some basic things to look for are:
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