What does Beta mean in Investing?
Beta β measures the volatility of a stock in relation to the total market’s volatility. The total market is assigned a beta of 1.0 as a reference.
Stocks with a beta greater than 1.0 are said to possess greater volatility than the market. Stocks with beta’s under 1.0 have lower volatility than the market. Also, there are even stocks with negative beta values. Those stocks basically move the opposite direction of the market in regards to volatility.
It is super important to understand that beta or volatility is NOT a measurement of risk. This is easy to understand because beta doesn’t play favorites with upside or downside volatility. It simply measures volatility. For example, If a stock possessed greater upside beta, you probably wouldn’t complain. It is only the downside volatility that concerns most investors.
An example to clarify the meaning of beta:
Suppose the total market goes up 5%. A stock with a beta of 2.0 would go up two times as much or 10%. A stock with a beta of 1.5 would go up 7.5%.
There has been many studies on low versus high beta stocks. The conclusions are at some point, you are not compensated for high beta’s; you are taking on unnecessary risks. I recommend the book “The Missing Risk Premium” by Eric Falkenstein if you want a detailed technical book about beta, risk, and out-performance.
Something you need to keep in mind when looking at beta- It’s BACKWARD LOOKING. Beta isn’t a guarantee, nor does it tell you anything about the future performance. Just because a low beta stock performed great in the past, doesn’t mean it will perform well next year. So, understand, if you pick a bucket of low beta stocks, that tells you nothing about future performance.
There are certain stocks that have a history of having low betas. These stocks are usually found in sectors like Consumer Staples, Utilities, or Healthcare. Think McDonalds, Verizon, or Kroger.
If you are interested in the mathematics behind Beta and how to use Excel to calculate I recommend this page.
How can low beta stocks help your portfolio?
Low beta stocks are less volatile so they can balance out a portfolio that contains higher beta stocks. This can potentially reduce maximum drawdowns if you believe we are going into a bear market. Once again, beta alone doesn’t predict returns. Personally, I think you must look at low beta stocks in relation to the overall portfolio and picture, not in isolation. How do they interact with your entire portfolio? What is the beta of your entire portfolio? Those are important questions to ask and there many tools that can help you calculate that.
What are some typical low beta stocks?
Here is a list of low beta stocks I came up with arranged from lowest beta value to highest. All of these Beta values were calculated over the last year and are below 1.0. It’s not comprehensive, but it will give you an idea. Notice the number of consumer staples and health related stocks.
|Johnson and Johnson||.32|
|British American Tobacco||.48|
|Proctor & Gamble||.67|
If you dug up the performance of these stocks over the last year, you’d find some that outperformed; however, you’d find those that under performed as well.
Now, I purposely left off some stocks because I took the low beta stock screen and I narrowed it down further. I took these low beta stocks and filtered by stocks with high revenue growth over the last year. Here are the results:
Stocks with a beta of less than 1.0 AND High Revenue Growth
- Dominion Energy
- Cal Maine Foods
- Tootsie Roll
- Southern Company
- Realty Income
- McGrath Rent Corp
- Allison Transmissions
- Exxon Mobile
- Monster Beverage
- Werner Trucking
- Archer Daniels Midland
This simple extra screen could provide possibilities to look into. I think one must be careful when looking at revenue growth, understand future revenue growth may slow. Especially in the case of something like an oil stock at this point in time.
I saw some familiar names on this list. I used to own McGrath Rent Corp before I sold it in 2020. It is a nice little small cap value stock. I currently hold Allison Transmission and have mentioned it numerous times. Many of these companies pay nice dividends as well For example, Realty income is a popular REIT dividend stock. STOR is another REIT paying over a 5% dividend. This is one Warren Buffett owned for a bit!
Exxon Mobile pays a large dividend (I currently own this in my XLE ETF, as well as Chevron). I was a bit surprised at Monster Beverage as it’s been a growth stock with some huge gains for a number of years.
What this shows is sometimes a low beta stock is also a value stock. It has been put forth that the reason many low beta stocks perform so well is that they are also offering the VALUE FACTOR.
Closing words about low beta stocks
As always, I’m not a professional advisor. My goal is to teach more about investing, the terms and ideas involved. It is to give you knowledge about how to think about your own investing. I do think low beta stocks have a place in the portfolio, whether that be through individual purchases or a low beta ETF (those exist!). However, they work and interact within the ecosystem of an entire portfolio. Understand how your portfolio is operating before adding these sorts of stocks.
Frequently asked questions about Beta
Low beta by itself doesn’t indicate whether a stock will offer better performance in the future. However, in the context of an OVERALL PORTFOLIO, low beta stocks can lead to less volatility.
Beta is calculated as follows: β = Covariance of the Equity / Variance of the Total Market