What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


Limitations of Beta Stocks

Original post by Jacquelyn Jeanty of Demand Media

Stock reports provide a range of information on stock performance within the market. Different types of information can portray stock values from different perspectives. Beta stock values represent one perspective on a stock's overall performance in the market. While informative, this one perspective has limitations in terms of a stock's current and future value.

Stock Values

A company's stock value can vary over time depending on the overall strength of a company and changing economic or market conditions. In other words, high stock values from a year ago may or may not reflect the current or future value of a stock. Determining a stock's true value requires investors to consider its past, present and expected, or future performance. Beta stock values provide indicators of a stock's past performance in relation to how the market performed at the time. So, if a stock out-performs the market, it carries a positive or +1 beta value, while under performing stocks carry a --1 beta value. Beta values can exceed +1 or --1 depending on how well (or poorly) a stock performs.

Volatility

Within the stock market, volatility refers to a stock's movement in terms of increases and decreases in value. Volatility also applies to a stock market's movements as a whole, otherwise known as the market index. Beta stock values directly relate to a stock's volatility within the market. In effect, volatility indicates the amount of risk attached to a particular stock or to the market itself. So, a stock with a positive, high beta value has produced favorable profits when compared to gains made throughout the market. Limitations surrounding beta stock values have to do with their focus on a stock's past performance within a given time. This focus fails to consider the effects of other factors, such as changes within a particular product market or a company's overall strength and standing within the market. These factors can have a significant influence on a stock's performance over time.

Historical Data

Beta stock values provide a historical perspective on a company's performance in relation to current market conditions. In effect, historical or past data regarding a stock's movement forms the basis for a reported beta stock value. These time factors become a limitation when comparing long-standing established companies with newly formed companies. It's not unusual for a company with a long history to have low beta stock values because of their ongoing presence in the market. On the other hand, a newly formed company that specializes in a new technology product may show high beta values simply because they've just entered the market with a new product. Over time, the established company may continue to show consistent gains while the beta stock value for the new company decreases as its "newness" wears off.

Market Conditions

Market conditions can have a far-reaching effect on how individual stocks within a market perform. Down-swings or up-swings within one or more areas of the market can have ripple effects across different market sectors. When this happens, individual stocks become more volatile during up and down periods. In effect, the market conditions surrounding a beta value may provide a key piece of information regarding a stock's ability to generate profits (or losses) on a short-term or long-term basis. This lack of information places limitations on beta stock values in terms of determining the rate of return (or loss) to expect from a particular company's stock.

                   

Resources

References

About the Author

Jacquelyn Jeanty has worked as a freelance writer since 2008. Her work appears at various websites. Her specialty areas include health, home and garden, Christianity and personal development. Jeanty holds a Bachelor of Arts in psychology from Purdue University.


Advertisement