In recent months investors and traders often heard the term “volatility.” Volatility is something investors hear in the news during a downturn in the broader market or if stocks are simply getting a beating due to the current inflationary environment, interest rate decisions, or even the latest debt ceiling worries. But did you know that “volatility” isn’t just a signal for impending losses or danger in the market but also a way for investors to manage risk and build their long-term portfolios? In finance, investors read about volatility being a proxy for risk or what may call systematic risk; as portfolios become more volatile, they tend to be looked at as riskier. Beta allows investors to quantify the price risk of a security or portfolio against its benchmark using its volatility, which is typically the broader market like the S&P 500. So in general, beta tells investors how a stock or portfolio would move by the moves of its benchmark.
How to Read Beta
When a stock moves in unison with its benchmark, its beta will show as 1. However, the lesser the movement of the stock to its benchmark: its beta gets lower. And if it's higher, then beta increases. In short, Beta shows the relative movement of a security to its benchmark or, in most cases, the market. High-beta stocks are considered the riskiest but provide higher return potential, and low-beta stocks pose less risk and lower returns.
Let's look at some example beta values against the S&P 500:
1 - the stock moves at the same pace as the S&P 500.
2 - for each point of movement of the market moves, the stock moves twice as much as the S&P 500.
0 - the stock does not have any correlation with the S&P500’s movements
-1 - the stock moves the same way as the S&P 500 but in the opposite direction.
Also importantly, negatively correlated securities would be expected to rise when the overall market falls, or vice versa.
Interestingly enough, as of late, low-beta stocks have been outperforming the market, offering investors long-term options with a lower risk.
The Curious Case of Low Beta Stock Outperformance
Now that we understand that Beta helps investors understand the overall price risk of stocks during market downturns, how does it affect investors' stock selection? Beta helps investors gauge a stocks' potential for drawdowns even with drastic market conditions due to the correlation of the stock to the market. This is very helpful to investors looking for long-term positions or those close to or already in retirement.
A paper from Harvard Business School suggests that in all market conditions, low Beta stocks outperform the market disproving the conventional thought on Beta stocks. The same study suggested that low Beta stocks outperform several percentage points annually. In a long-term or retirement portfolio, this sort of outperformance can mean the difference between having a relaxing retirement and enjoying the fruits of your labor or longer working years due to the significance of returns when compounded over time. While low Beta stocks aren’t the end-all-be-all for stock selection, their case for outperformance over time with lower risk is quite attractive.
How To Calculate Beta
The following formula can calculate beta:
Covariance measures how two securities move together, wherein a positive covariance means that both securities move together in the same direction. A negative covariance means that the securities move opposite each other.
With Variance, it refers to how far a stock moves relative to its mean. For example, variance is used in measuring an individual stock's price volatility over time. Covariance is used to measure the correlation in price moves of two different stocks.
So the formula calculates beta using the covariance of the return of security with the return of the benchmark, divided by the variance of the benchmark's return over a certain period. An alternative is to use Beta could also be calculated by first dividing the security's standard deviation of returns by the benchmark's standard deviation of returns. The output is then multiplied by the correlation between the security's returns and the benchmark's returns.
This may sound difficult, but Barchart takes care of this for you and offers the stocks' Beta in the company profile.
With low Beta’s potential for outperformance, let’s look at low-beta stocks outperforming the market.
Minerva Neurosciences Inc. (NERV)
YTD Return: 254.72%
5-Year Beta: 0.08
Minerva Neurosciences, Inc. is a clinical-stage biopharmaceutical company focused on developing and commercializing a product that will help treat patients suffering from central nervous system (CNS) diseases. The Company's lead product candidates are:
- Roluperidone (MIN-101) - a compound that blocks serotonin, sigma, and α adrenergic receptors involved in regulating mood, sleep, cognition, and anxiety. The Company is developing risperidone to treat patients with schizophrenia, which is designed to block a specific subtype of serotonin receptor called 5-HT2A.
- MIN-301 - a soluble recombinant form of the Neuregulin-1b1 (NRG-1b1), protein, for treating Parkinson’s disease and other neurodegenerative disorders.
The Company is also developing an insomnia disorder treatment using a suvorexant and adjunctive treatment for major depressive disorder (MDD).
Semantix Inc. (STIX)
YTD Return: 223.68%
Beta: 0.06
Semantix Inc, formerly Alpha Capital Holdco Co is a Brazil-based company that develops a data-centric platform that accelerates digital transformation and enhances business performance. The company provides seamless, low-code, and low-touch data analytics solutions that allow its customers to access data from any source and develop appropriate analytics to meet their business and industry needs. The Company’s internally developed, frictionless, end-to-end Software as a Service (SaaS) data platform, Semantix Data Platform (SDP), guides customers through their entire data lifecycles. This includes capturing data, structuring that data in the form of a data lake, and providing easy access to such data for exploration and interaction. This also allows users to create reports, dashboards, and algorithms fueled by the data to enhance business performance.
Serra Prognostics Inc. (SERA)
YTD Return: 173.81%
Beta: 0.27
Sera Prognostics, Inc. is a women's health diagnostic company that is focused on developing, discovering, and commercializing clinically impactful biomarker tests, with an initial focus on improving pregnancy outcomes with its proteomics and bioinformatics platform. The company’s proteomics and bioinformatics platform helps characterize the biology of pregnancy and helps discover and validate key protein biomarkers found in the blood. This helps provide accurate predictors of dynamic changes that occur during pregnancy. The company also has a commercial product, the PreTRM test, a blood-based biomarker test to accurately predict the risk of premature delivery, also known as preterm birth. The PreTRM test is a non-invasive blood test given to a pregnant woman carrying a single fetus during weeks 18 to 20. The company also has a biomarker pregnancy pipeline that includes the following:
- Preeclampsia
- Molecular time-to-birth
- Gestational diabetes mellitus (GDM)
- Fetal growth restriction
- Stillbirth
- Postpartum depression
TScan Therapeutics Inc. (TCRX)
YTD Return: 157.42%
Beta: 0.31
TScan Therapeutics is a clinical-stage biopharmaceutical company focused on developing T cell receptor-engineered T cell therapies for cancer treatment. Their main candidates, TSC-100 and TSC-101, are currently being studied in clinical trials to treat hematologic malignancies and prevent relapse after cell transplantation. The company is also working on developing multiplexed TCR-T therapies for solid tumors. The company is advancing six solid tumor programs:
- TSC-204 is entering Phase I development.
- TSC-200 and TSC-203 are in the process of IND-enabling activities.
- TSC-201 is undergoing lead optimization.
- TSC-202 and TSC-205 are in the discovery phase.
Nuvectis Pharma (NVCT)
YTD Return:125.33%
Beta: 0.36
Nuvectis Pharma, Inc. is a biopharmaceutical company focused on developing precision medicines for treating serious conditions in oncology. The company employs scientific insights into cancer-promoting factors, clinical landscape understanding, and regulatory requirements to select and develop its drug candidates. The company currently has 2 primary drug candidates in development:
- NXP800 - a clinical-stage, oral small-molecule inhibitor of the Heat Shock Factor 1 (HSF1) pathway for the treatment of platinum-resistant, adenine-thymine (AT)-rich interaction domain (ARID1a)-mutated ovarian carcinoma. It is currently the company’s lead candidate.
- NXP900 - a targeted-therapy, small-molecule drug candidate that inhibits the proto-oncogene c-Src (SRC) and YES1 kinases for treating SRC-associated solid tumors.
Final Thoughts
Like any investment, investors should always consider risk when making any investment. Beta provides a quick view of the stock's impact on an investor's portfolio and gauges if it coincides with an investor's investment goals. However, just because studies argue that low-beta stocks outperform the market does not mean it has to be the only investment consideration. Due diligence goes a long way in ensuring long-term goals with risk management are still in place.
On the date of publication, Rick Orford did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
