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WIKI ANALYSIS| This article is part of WikiProject Definitions. Consider editing to improve it. View articles referencing this definition. |
Beta, or the beta coefficient, measures the correlation between an investment's value and movements in the overall market. A high beta implies a stock price grows dramatically when the market is up, and falls dramatically when the market goes down. Small values of beta mean the stock price is relatively unaffected by the swings in the overall market.
Because Beta is a comparison to the overall market, a benchmark or baseline representing the overall market is needed - usually, the S&P 500 is used, although betas can also be calculated against industry-specific indices. Precise methods for calculating Beta can differ.
- A beta of 1.0 means that the security's price, historically, has moved with or has been equally as volatile as the market - when the market is up 10%, the security's price has generally also been up 10%
- A beta higher than 1.0 means that the security's price has been more volatile than the market - A beta of 2.0 means that when the market is up 10%, the security's price has generally been up by 20% (and down by 20% when the market is down 10%).
- A beta lower than 1.0 means that its price has been less volatile than the market - A Beta of 0.5 means that when the market is up 10%, the security's price has been up 5% (and down by 5% when the market is down 10%).
- A beta of 0 means that the stock is independent of the market and its movements are not correlated.
- A negative beta means that the stock moves inversely with the market. When one rises, the other falls and vise versa. Precious metals and inverse ETFs often have negative beta values since their values tend to increase as the market falls.
The difference between a security's beta and 1.0 can be thought of as a percentage of volatility. Assuming beta is accurate, a stock with a beta of 1.75 is 75% more volatile than the market. Similarly, a stock with beta of 0.7 would be 30% less volatile than the market.
For individual companies, beta can be estimated using regression analysis against a stock market index. It is required input to the Capital Asset Pricing Model (CAPM), which is used to calculate the expected return of an asset based on its beta and expected market returns.
Variances in Beta
Values of Beta can vary depending on how they are calculated. Specifically, the main varying components are:
- Different time frame: Depending on how far back into history the beta calculation goes, the values will differ. For example, if one calculation includes the stock prices for the trailing 12 months versus the trailing 60 months; the two values will be different.
- Different time intervals: Depending on the interval between the stock prices used, beta calculations can differ. For example, one calculation which uses the monthly stock prices will differ from another calculation which uses weekly or daily stock prices.
- Different index: Beta calculations can vary depending on which index is used to measure the overall value in the market. For example, using the S&P 500 (.SPX-E) and the Dow Jones Industrial Average (.DJIA) will result in different values.
- Inclusion or exclusion of dividends: Depending on whether dividends are included in the calculation of the returns of the stock, the beta calculations can differ.
The result of each of these different choices can cause beta values to differ widely depending on how the calculation is made. This means that a beta value is not an exact value of how a stock varies with the market, but a representation.
Beta and investment manager performance
When evaluation the performance of a fund manager, Beta is used in contrast with Alpha to denote which portion of the fund's returns are a result of simply riding swings in the overall market, and which portion of the funds returns are a result of truly outperforming the market in the long term. For example, it's relatively easy for a fund manager to create a fund that would go up twice as much as the S&P 500 when the S&P rose in value, but go down twice as much as the S&P when the S&P's price fell - but such a fund would be considered to have pure Beta, and no alpha. A fund manager who is producing Alpha would have a fund that outperformed the S&P 500 in both good times and bad.
Examples
- Company ABC, a tech stock, has a beta of 1.8. Over a given year, the NASDAQ Composite Index increases in value 17%. Assuming the beta value is accurate, ABC's value would have increased 30.1% or (1.8 x 17%) over the same time period.
- Company XYZ, a mid-sized oil company, has a beta of 1.0. Over a given year, the S&P 500 Index falls 8%. Assuming the beta value is accurate, XYZ's value would also have fallen 8% over the same period.
- Company LMN, a gold mining company, has a beta of -1.4. Over a given year, the S&P 500 Index increases in value 11%. Assuming the beta value is accurate, LMN's value would have declined 15.4% or (-1.4 x 11%) over the same period.
How Wikinvest calculates Beta
The beta values on Wikinvest use the prices for the trailing 60 months (5 years) on a monthly interval to ensure a high level of accuracy and stability and to avoid the calculation being altered or thrown off by outliers. In addition, Wikinvest uses the S&P 500 (.SPX-E) as an index of the price value of the market and the adjusted close price value of an individual stock (adjusted close takes into account dividends). These monthly price values are then used to calculate the monthly return of the stock and of the market. Wikinvest then uses a linear regression analysis on:
Rs = a + b*(Rm) + e
where
- Rs is the monthly return of the stock
- Rm is the monthly return of the market
- b is the beta value
- a is the Alpha value
- e is a margin of error.
Note: a linear regression means to find a single line which fits the data points given the best.
This method of calculation allows wikinvest to achieve a high level of accuracy in stability because it takes into account a long history. In addition, the monthly price levels prevents the beta calculation from fluctuating rapidly with short run changes in the market. Finally, the inclusion of dividends matches the inclusions of dividends in the S&P 500 (.SPX-E) and so ensures a high level of accuracy. This method is identical to many large financial services like Google Finance, but is different from how Yahoo Finance. Thus the Yahoo Finance differ from Wikinvest's and Google Finance's values and are the result of one or a combination of the variances explained above.
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