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All reviews are prepared by our staff. Opinions expressed are solely those of the reviewer and have not been reviewed or approved by any advertiser. The information, including any rates, terms and fees associated with financial products, presented in the review is accurate as of the date of publication. SHARE: svetikd/Getty Images August 12, 2022 Checkmark Bankrate logo How is this page expert verified? At Bankrate, we take the accuracy of our content seriously. "Expert verified" means that our Financial Review Board thoroughly evaluated the article for accuracy and clarity. The Review Board comprises a panel of financial experts whose objective is to ensure that our content is always objective and balanced. Their reviews hold us accountable for publishing high-quality and trustworthy content. Greg McBride, CFA, is Senior Vice President, Chief Financial Analyst, for Bankrate.com. He leads a team responsible for researching financial products, providing analysis, and advice on personal finance to a vast consumer audience. Lance Davis is the Vice President of Content for Bankrate. Lance leads a team responsible for creating educational content that guides people through the pivotal steps in their financial journey. Allyson Johnson leads marketing and fundraising for Gateway Partners. She is a CAIA charter holder and has passed the CFA Level II examination. Bankrate logo

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What is beta and how does it work

Beta is a way of measuring a stock’s volatility compared with the overall market’s volatility. By definition, the market as a whole has a beta of 1, and everything else is defined in relation to that: Stocks with a value greater than 1 are more volatile than the market, meaning they will generally go up more than the market goes up, and go down more than the market goes down. Stocks with a beta of less than 1 have a smoother ride as their moves are more muted than the market’s, but they’ll usually still go up when the market goes up and down when the market goes down. Securities with a negative beta, which is unusual, will typically move inversely to the market. So when the market goes up, these securities fall, and vice versa. To calculate beta, investors divide the covariance of an individual stock (say, ) with the overall market, often represented by the , by the variance of the market’s returns compared to its average return. Covariance is a measure of how two securities move in relation to one another. Beta can help give investors an idea of the risk in a given stock, and it’s a useful, if incomplete, way of doing so.

Using beta to evaluate a stock s risk

Beta allows for a good comparison between an individual stock and a market-tracking , but it doesn’t offer a complete portrait of a stock’s risk. Instead, it’s a look at its level of volatility, and it’s important to note that volatility can be good and bad. Investors aren’t complaining about upward price movements. The downward price movement, of course, will keep people up at night. Think of comparing the beta of different stocks in the same way you might order food at a restaurant. If you are a more risk-averse investor who is focused on earning income, you might shy away from high-beta stocks the same way that someone with a simpler palate might prefer to order a plain dish with familiar ingredients and flavors. A more aggressive investor with a higher might be more inclined to chase the high-beta stocks the same way an adventurous eater will look for new, spicy dishes with exotic ingredients they have never tried. Beta is a data point that is widely available. You’ll find this alongside other metrics of a stock’s price when doing your research — .

Pros and cons of using beta

Pros

History can hold important lessons: Beta uses a sizable chunk of data. Typically reflecting at least 36 months of measurements, beta gives you an idea of how the stock has moved vs. the market over the last three years. Numbers don’t lie: Rather than combing through press releases about past product launches or trying to read between the lines of what a company’s CEO might have said at the investor day last year, and how the stock reacted to these various pieces of news, beta mathematically represents the stock’s moves for you.

Cons

You’re looking in the rearview mirror: Beta is a backward-looking, singular measure that doesn’t incorporate any other information. Sure, it’s good to reflect on what the past three years looked like, but as an investor, what you care about is what’s in store for the next three years. You want to think about business prospects and potential market disruptions on the horizon. That’s why beta is only one part of your research. Numbers aren’t everything: Beta doesn’t include qualitative factors that can play a significant role in a company’s outlook. Did that renowned CEO step down during those three years? Now that the succession plan is in place, perhaps the future will look quite a bit different. The measurement doesn’t work with young companies: As plenty of hype swirls around , beta is one number that will never be part of the conversation. Because it’s calculated on historical price movements, you can’t effectively use beta to evaluate companies that have plans to go public or young companies that have recently been listed on Wall Street. SHARE: Greg McBride, CFA, is Senior Vice President, Chief Financial Analyst, for Bankrate.com. He leads a team responsible for researching financial products, providing analysis, and advice on personal finance to a vast consumer audience. Lance Davis is the Vice President of Content for Bankrate. Lance leads a team responsible for creating educational content that guides people through the pivotal steps in their financial journey. Allyson Johnson leads marketing and fundraising for Gateway Partners. She is a CAIA charter holder and has passed the CFA Level II examination.

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