In equity investment or for that matter in the entire investment space, volatility or the risk is determined using a metric called beta value. This is calculated relative to the benchmark index. The beta of the benchmark index is 1 while that for the mutual fund or the scrip is always specified.
How to compute beta?
In the stock market, the beta for a scrip suggest the rate or the pace at which the scrip moves in tandem with the overall market movement. Formula of beta is computed as:
Covariance of a specific stock relative to the benchmark index/ Variance of the scrip in some defined period.
Risk-return potential of high beta stocks
In a bullish market as is the current situation betting on high beta stocks can be lucrative with potential to generate higher return for investors. In the weakening market however, any sharp fall can be detrimental for the investors portfolio if it comprises more stocks with high beta.
Beta of Indian stocks
Primarily beta for Indian shares can be of 4 types:
1. Beta higher than 1:
The share or investment here moves more in line with the benchmark index i.e. shows high responsiveness. So, small and mid cap with potential to generate a higher return fall under thus category. Nonetheless, in the case of a weak market, because of weak fundamentals these companies are not sufficiently capitalised to cover up the loss. As an example if the stock's beta is 1.4 then it is 40% higher volatile than the market.
2. Beta less than 1:
These shares have a parallel effect with share price movement in a fashion similar to benchmark indices. Large cap companies carry a beta value of 1
3. Beta is 0
Herein the scrips or investment options do not show any price movement in relation to market say for instance bank FDs, bond etc. Investors who need to protect their capital can invest in instruments with beta as zero value.
4. Beta is negative
These are investments which yield results against the stock market movement. These investment options are often referred as safe havens such as the US dollar, gold etc.
Who should in beta investments?
Primarily a person's or investors risk profile shall be a deciding factor to decide on what beta investment to opt for. While risk averse investors need to go for securities with beta as zero value or less than 1, those with a higher risk appetite can go with high beta value or investments with beta value more than 1.