Beating The Market With Beta

This week I want to talk about ‘beta’.

As investors try and protect themselves from ‘market risk’ and volatility, a quick look at your stock’s beta could help you determine your co-movement measure.

First and foremost, ‘beta’ is a measure of an asset’s risk relative to the ‘market’ (usually the S&P 500). (It’s typically calculated as the ‘performance a stock has experienced in the last 5 years as the S&P has moved up and down’.)

A beta of 1 means the stock’s relative volatility is equal to that of the market. Therefore, a beta that’s greater than 1 is more volatile than the market, while a beta of less than 1 is less volatile. (It can also be explained as its excess movement or ‘return’.)

For instance, a beta of 1.5, will have 1 1/2 times the market’s movement (50% more movement than the market). But if the market is plummeting, more than likely you’re dropping even more than the market.

Take the following statistics for example. I ran two tests on the Research Wizard; one for stocks with betas half as much as the market and one with betas 50% more than the market.

I must say, I’ve run this test before. This time, though, I was a little surprised by some of the numbers - but not by the difference between high beta and low beta stocks.

For example:

Over the last twelve weeks, the S&P 500’s percentage price change was down by approximately 12.70%.

My first test focused on higher beta stocks (stocks that had betas of one and a half times the market — in theory, 50% more market risk/volatility). In this test, the median twelve-week percentage price change was down by 14.84%.

This surprised me at first in that it wasn’t down by 50% more than the market. Although, since the market was acting in such an extreme manner, I suppose it’s hard to see a relatively large subset of stocks go down by a median value of nearly 20%. (But just to be sure, there were plenty of stocks that were down that much and more.) Nonetheless, the median downside risk was nearly 17% more than the market.

My second test looked at stocks with betas of less than .5 or half the market’s volatility. In this test, the median twelve-week percentage price change was only down 1.14%!

This number was even more surprising. Not only did these stocks exhibit less downside risk or co-movement than the market, but it was way less than half. In fact, the low beta stocks cut the losses by 91%.

(Both tests were applied to stocks with prices >= $5 and average daily share volume of >= 50,000.)

Of course, beta alone isn’t a magic item, but it can help you minimize unnecessary market risk and volatility when used in conjunction with other proven stock-picking techniques.

Here’s a screen I’m currently using to scan for good stocks with half the market’s volatility.

• Zacks Rank = 1
• Beta < .5 (half the volatility of the S&P 500)
• Price >= 5
• Avg. 20-day Volume >= 50,000

Currently, there are 20 stocks on this list. Here are 3 of them:

(CYBX) Cyberonics, Inc.
(ILMN) Illumina, Inc.
(UGI) UGI Corp.

Start using the beta indicator in some of your own screens and see if it helps you smooth out your portfolio’s volatility. Then test it all out with our backtesting feature.

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