Beta
Beta is a measure of price volatility. It compares how much the stock's price moves relative to a known market, such as the S&P 500.
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Expanded Definition
Before discussing what the number means, let's look at how it is calculated. The price movement of a stock over time is compared to the price movement of some comparable index. The amount that the stock's price moves relative to the movement of the index is the beta. By definition, when the two move in lockstep, the stock's beta is 1.0. For instance, the stock moves up 5% when the index moves up 5% and down 3% when the index moves down 3%.
Stocks whose price moves by a lesser amount will have a value lower than 1. Stocks that move in larger steps on average than the market, rising and falling rapidly, will have betas greater than 1. The larger the number, the more volatile the stock.
Beta values can be positive (which means the stock and index generally rise or fall together) or negative (which means the stock price generally rises when the index falls, and vice versa). A beta of zero means that there is no correlation between the movement of the stock's price and the index's price.
Limitations of beta
The actual value calculated depends heavily on several things:
- The length of time sampled. Three years will give a different result from five years.
- The frequency at which the prices are sampled. Once weekly will give a different result from once daily.
- When the prices are sampled. At close Monday will give a different result from at close Wednesday or at open Friday, for example.
- The choice of index. A small cap should probably be compared to a small-cap index, like the Russel 2000, instead of the S&P 500, which is a large cap index.
Because of these differences in how beta is calculated, different sites which report beta will very often report (sometimes drastically) different numbers. Be sure that you understand how beta is calculated for the site you use as your source.
Also, because companies change over time, beta will also change.
Beta as a proxy for risk
For many investors, the proxy for risk is volatility. That is, if the price moves up or down a lot, it is often considered more risky than if the price does not move with as large jumps. But that view is flawed for a couple of reasons. First, even very large companies can see the price of their shares move a lot in a very short period of time. When GE or Berkshire Hathaway see their prices move by several percent, you can see that these relatively low-risk companies can still have volatile stock prices. Second, risk is the potential of losing your invested money. That comes about from investing in companies with poor management, lots of competition and poor products, and items such as that. It does not come about from the random fluctuations of the stock price.
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