Beta is a measure of risk and volatility a portfolio or stock has in comparison to the overall market’s risk. It is used to calculate the expected return of an asset in the capital asset pricing model (CAPM) and is a useful measure of overall investment risk.
Beta Coefficient
The Beta coefficient uses regression analysis to calculate a number, generally ranging between -2 and 2. A Beta of 1 represents a nearly identical correlation with the movement of the overall market. For example, let’s take Apple Inc. (AAPL), which at the time of writing has a Beta coefficient of 0.99. If the market rises by 1% over the next year, AAPL stock would be expected to do the same, because its Beta is nearly 1. By the same logic, if the market was expected to drop by 1%, AAPL stock would be expected to drop by the same amount.
Another stock, Ford Motor Co. (F), has a higher Beta of 1.17. This indicates that the stock has a 17% higher volatility than the market. Following the logic above, a 1% increase in the market should translate to a 1.17% increase in F stock. Likewise, a 1% decrease in the market should result in a 1.17% decrease in F.
A negative Beta indicates a negative correlation to the market. A stock with a beta of -0.5 is expected to go up 0.5% for every 1% decrease in its underlying index (market). A stock with a Beta of -2 is expected to go down 2% if the index goes up 1%.
It is important not to become too reliant on Beta, as it is a historical indicator and does not necessarily represent future behavior. There are many factors that can change the Beta score in an unpredictable manner; therefore, investors are encouraged to perform research to understand how the stock’s Beta score developed.