What is BETA in the Stock Market?

Last Updated: 13 Jan 2025

The higher the risk, the higher the returns. This is a common adage attached to the stock market. Every investor who enters the stock market hopes to earn the highest amount of profits with the invested amount. However, stocks that offer high potential profits come with a high risk of losing capital or depreciating value. In such cases, investors are left with no choice but to analyze their risk appetite and invest in stocks that limit risk exposure.

However, for investors to choose stocks that match their risk appetite is tricky. For example, a high-risk investor who has diversified within asset classes may want to invest in high-risk stocks as they can offer higher returns. On the other hand, an investor who is just starting in the market may want to invest in less risky stocks even though they may offer lower profits.

What is BETA in the Share Market?

BETA in the share market is an indicator used by investors to assess the risk attached to a specific stock. It is a great way for investors to measure a stock’s volatility and ensure that they adjust their positions or buy/sell the stock. BETA in the stock market works by assessing the risk of stock concerning the overall stock market. For example, BETA in the stock market defines the risk of a stock concerning stock market indices such as NIFTY, SENSEX, etc. If the indices are rising, but the price of the stock is falling, an investor can assess this risk through the BETA values.

Understanding BETA in share market meaning

The method of BETA assigns a value of 1 to the stock market or any comparable indices such as NIFTY or SENSEX. Afterward, individual stocks are ranked above or below 1 based on how much they deviate from the overall market’s performance or the indices. If the rank given to a particular stock is above 1, it means that the stock is moving more than the market and is called a High BETA stock. However, if the ranking is below 1, it means that the stock is moving slower than the overall market and is called a low BETA stock.

For example, suppose invest in the stocks of ABC Company. You want to assess the risk attached to the stock and whether it is a high BETA stock or a low BETA stock. It is calculated as below:

Beta (β) = Co-variance of a specific stock with a benchmark index of the share market/The variance of the respective security over a specific period.

Now, you need to find the BETA value compared with NIFTY. Based on the recent five-year data, the correlation between ABC and NIFTY is 0.50, the standard deviation of returns of ABC is 25.50%, and NIFTY is 30.50%. In this case, the BETA value will be:

BETA of ABC = 0.50x (0.2550/0.3050) = 0.4180

As the value is lower than 1, the shares of ABC would be considered less volatile than NIFTY.

Types of BETA in the stock market

There are four types of BETA values, allowing investors to understand the risk attached to the stocks. These are:

• β>1: BETA value greater than one with a stock implies they are performing better than the overall market. These stocks are called high BETA stocks and can allow investors to earn substantial profits. However, such high BETA stocks accompany a high-risk factor with a possibility that the price can crash anytime to average with the present market.
• β<1: BETA value lower than 1 with a stock implies they are performing lower or close to the overall market. These stocks are called low BETA stocks and can allow investors to earn lower but steady returns. Such stocks come with a low-risk factor and are considered stable against the volatility of the market.
• β=1: BETA value equal to 1 signifies that the stock is ideally co-related to the stock market or the indices. These stocks are also considered stable and have a parallel effect on the share price and the returns with market fluctuations as the comparable indices. Generally, stocks of large-cap companies have a BETA value equal to 1 as these companies are the major part of such indices.
• β<0: Securities other than stocks have a BETA value of 0 when compared to stock market indices. For example, gold is a security that may have a BETA value of 0, signifying that its value may rise over time, irrespective of how the stock market indices are performing. Investors use these securities to hedge against a stock market crash.

BETA in theory vs. BETA in practice

There is a well-known argument regarding BETA as it does not differentiate between a stock’s upside or downside price movement. It may be that the market is falling continuously, and yet a stock may have a BETA value lower than 1, as it may also be declining continuously. For investors, falling prices are a risk, while climbing prices are an opportunity for making profit. However, BETA doesn’t clarify this difference. Therefore, investors need more intuitive tools to make informed decisions, which can be found on a reliable trade terminal or stock trading app.

Value investors do not believe in BETA as it promotes that a stock that has fallen sharply in price (β<1) would not give better profits than stocks that have climbed in price (β>1). On the contrary, value investors think that such stocks provide better profit-making opportunities over time.

Understanding the BETA stock market definition can help you know how high the risk can be when investing in stocks and allow you to make informed decisions. The market has a BETA of 1.0, and the BETA ratio in stock indicates how it might move.

Who Should Invest in Beta Stocks?

The beta helps investors recognise the risk factors associated with specific securities. Individuals with a high-risk aptitude can invest in stocks with beta values greater than 1 to ensure significant portfolio returns. However, such investors should be ready to face significant losses if unexpected events cause the stock market to decline.

Small and mid-cap firms generally have beta values of over 1 on the respective stocks due to their expansive growth potential. Investment in their stock or bonds could lead to large sums of money being generated over time in terms of annual return. The said returns can be availed of by individuals either through dividend payouts or capital gain through resale at a later time.

A risk-averse investor can select a stock beta less than 1 for a relatively stable investment venture. Fixed return instruments are generally related to such a beta value because stock market fluctuations do not directly influence the returns of respective instruments.

The beta value of stocks can also be 1, indicating the same fluctuation rate among indices and corresponding securities. Large-cap companies generally have a beta value equal to 1 because they form the major components of a country’s indices.

Even though investment in such securities does not generate enough capital gains, the high-value payouts in the form of dividends frequently generate wealth for investors. Investment in such companies is desirable because they have adequate financial resources that would enable the management to arrest the downswing of the business cycle, thereby implying no drastic change in the stock price.

Advantages of Beta Stocks

Beta stocks, classified by their sensitivity to market movements, play a critical role in portfolio management. Their beta value indicates how much a stock is likely to move compared to the overall market, providing several advantages:

• High Beta for Growth Opportunities: Stocks with a high beta (greater than 1) tend to outperform the market during bullish trends. Investors seeking aggressive growth can leverage these stocks to generate substantial returns when markets rise.
• Low Beta for Stability: Low-beta stocks (less than 1) are less volatile and offer stable returns, even during turbulent market conditions. These stocks are ideal for conservative investors looking to preserve capital while earning moderate gains.
• Portfolio Diversification: Incorporating both high- and low-beta stocks into a portfolio ensures a balance between risk and reward. This diversification mitigates the impact of market volatility on the overall portfolio.
• Strategic Market Insights: Monitoring beta values provides valuable insights into how individual stocks will likely react to market movements. This information helps investors make informed decisions and align their strategies with market conditions.

Disadvantages of Beta Value of Stocks

The beta value of securities does not indicate the systematic risk associated with these investment tools. In other words, how the issuing companies perform cannot be understood through such coefficient figures. So, there always remains a risk of investing in value-trap securities if one invests by pooling money based on only a beta in the share market.

Conclusion

Thus, the beta value of stocks is an indispensable tool that investors must consider before investing in any stock market instrument. Though it does not incorporate the all-rounded value, beta helps analyse the market risk of the stated instrument and its subsequent impact on returns.

Frequently Asked Questions

What is a good BETA for a stock?

A good BETA value depends entirely on your risk appetite. If it is higher, you can choose a stock with a BETA greater than 1. If your risk appetite is low, you can go for a stock that has a BETA value of less than 1.

What are the advantages of BETA

BETA can allow investors to access the risk attached to a stock. It is also a vital factor for investors who undertake the Capital Asset Price Model (CAPM) to understand a stock’s return potential.

Is a high BETA good or bad?

High BETA stocks can allow investors to earn hefty profits. However, as they come with a high-risk factor, they can be bad if your risk appetite is lower.

What values can BETA take?

BETA can take values lower, higher, equal and negative (0) values than 1.

Is beta less than 1 good?

Yes, a beta less than 1 is generally good for risk-averse investors. It indicates the stock is less volatile than the market, offering stability and consistent returns during market fluctuations. These stocks are ideal for preserving capital while minimizing the impact of broader market swings.

What does a beta of greater than 1 indicate?

A beta greater than 1 indicates the stock is more volatile than the market. It tends to move more dramatically during market changes, offering higher potential returns during bullish periods and posing increased risks during downturns. High-beta stocks suit aggressive, growth-oriented investors.