There
is risk associated with every type of risk. Stocks move with movement of share
market there are stocks which shows wide movement of stocks with movement of
stock market. Stocks shows very high movement in upside when share market is up
and stocks shows downward movement with movement of share market. There are
some shares which doesn’t shows wide variations with stock market, So for
measurement of risk associated with stocks is known as beta of that stock.
So Beta
is measure of volatility of a stock with respect to stock market movement.
Generally stock market Beta is considered to be 1.0. Now if any stock shows
more movement then stock market then Beta level of stock is more than 1.0. Now
if a stock shows a very less movement then stock market then its beta is less
than 1.0. So Beta level indicates the potential of stock movement with respect
to stock market.
1. Higher the Beta level of a stock higher the risk associated with
stock and higher will be the potential of higher return from stock.
2. Lower Beta level stocks have lower risks associated with stocks
and lower will be the potential of getting return from stock.
Beta Impact on Share price valuations:-
In capital asset pricing model i.e. CAPM beta is key component for
calculating the cost of equity. Where
cost of capital depicts the discounted rates used in stock market to arrive at
present value of company in forthcoming future cash flows.
Higher
the Beta higher will be cost of capital discount rate which in turn leads to
lower present value on the future cash flows.
Advantages
of Beta:-
There are following advantages of Beta:-
(i)
Stock volatility can be measured which otherwise
very hard to measure. If any person don’t want to take risk , he/she can invest
in low beta stocks.
(ii)
If you are follower of
CAPM then Beta is good measure for the same.
(iii)
It provides an important
measure to calculate cost of equity used in valuation method that discounts
cash flows.
Disadvantages of Beta
(i) Beta doesn’t tells about fundamentals of stock
(i) Beta doesn’t tells about fundamentals of stock
(ii)
It doesn’t reflect about debt level on company.
(iii)
It’s doesn’t reflect Historic value of Beta it
only tell about present value.
(iv)
It gives a very poor picture of future.
(v)
Beta gives useful information about stock price movement
for traders but not for long term investors.
(vi)
Beta doesn’t reflect about picture of stock movement in
upside or downside. If stock is getting down and down then even beta value be
on higher side. So investors may not differentiate from Beta whether stock is
in uptrend or downtrend.
Beta
says about price paid for the stock in relation to its future cash flow.