Why Should I be a New Investor?

Title: What Does Beta Mean?

Beta is the second letter in the Greek alphabet and it is also the second letter in Phi Beta Kappa, the name of an academic honors society established by students at William and Mary College in 1776. The term "beta" has another meaning that is a lot more important for those of us who invest in the stock market in the hope of getting a good, positive return on our money.

Beta is a calculation appended to individual company stocks that is a measure of volatility—the degree to which a stock rises or falls when compared to the S&P 500 Index which is an accepted measure of the market as a whole.

A Real Life Example:
How does beta become important to investors? Well, a personal story will help illustrate the point.

Many years ago when I first began to invest in the markets I put money into a mutual fund and happily watched it grow for a couple of years. I then took three weeks vacation during which I checked the S&P 500 Index average religiously every day noting that it rose further and then retreated a little, but I was a happy camper because I was certain that my investment increased in value while I was vacationing.

Imagine my shock when, upon returning home, I found I'd suffered a 30% loss in the value of my investment.

At first blush I didn't know what had happened but eventually I understood that the mutual fund in which I was invested was heavily weighted with technology stocks that carried high beta numbers. While the overall market had pulled back only a little, the fund in which I was invested pulled back a lot.

To bring the story to a close, I recognized the drop in value as a "paper loss." I did not panic and sell at the bottom, and I ended up recovering the value when the market began to rally again.

Beta:
As mentioned above, the S&P 500 Index is the starting point for calculations of beta.

• The S&P is a measure of the overall market and is given a beta value of 1.00.
• Any stock that might rise and fall exactly the same amount as the S&P would have a beta of 1.00.
• A stock with a beta larger than 1.00 is expected to have a greater volatility than the S&P 500.
• A stock carrying a beta of less than 1 but greater than zero is expected to move less than the market in general. It will not have as much upward or downward movement as the average market.

So stocks with beta numbers under 1.00 are more stable than the overall market and those with beta numbers above 1.00 are more volatile. Volatility on the up side is a good thing, but we need to remember that volatility also impacts the down side as happened to me in my story.

Charting Examples:
Next we will take a look at two charts that will service to illustrate the difference between stocks with high and low beta numbers. Each chart will show two price lines, one for the stock and one for the S&P 500, and the percentage gain and loss with both price lines starting at zero % on the left hand side of the chart. The S&P price line is labeled ^GSPC on both charts.

Chart #1, Exxon Mobile (XOM) vs. S&P 500 (^GSPC):

On the chart, Exxon Mobil is the blue line and the S&P is in red. Notice that the peaks and valleys of both lines happen on the same day but that the red S&P line falls further and rises higher than the blue Exxon Mobile line does. Checking the early March 2009 date we find the S&P has dropped nearly 30% while Exxon fell about 12%. Checking mid October highs, we see the S&P is up nearly 20% and Exxon is right at zero on the vertical scale.

The chart shows that Exxon Mobil, with a beta number of 0.35, is more stable than the S&P 500 Index.

Chart #2 Bally Technologies (BYI) vs. S&P 500 (^GSPC):

On this chart the S&P price line is again red, and the blue line is Bally. Again we see the peaks and valleys happen on the same day, and at the late November low Bally has fallen further than the S&P. At the January 09 peak, Bally has risen about 40% above the 0% line while the S&P is just touching it. At the October 09 peak on the far right of the chart Bally has risen about 120% above the 0% line and the S&P is about 14% above it.

Bally carries a beta number of 1.84 and is much more volatile than the S&P.

Summary:
The purpose of all this is to make the point that it is important to know the beta value of stocks in which you plan to invest so you won't be ambushed in the future.

• With low beta stocks your investment is "safer" in a bear market since the value will drop less, which is a good thing, but you won't get a very good return in a bull market, which is a bad thing.
• With high beta stocks you will dance with joy in a bull market but suffer great pain as you watch your investment value "plunge" when the market turns south, (be of good courage, there are ways to protect against the plunge.)
• If you are an investor who wants to spend the least amount of time possible attending to your investments, lower beta stock are for you. Better yet, use an indexed mutual fund that exactly matches the S&P 500 Index.
• If you are an investor open to buying AND selling stocks, then high beta stocks will work a great deal better for you; however, you'll have to spend more time managing your invested money.

Personally, I prefer to work with high beta stocks where the up side moves are greater and the return higher. My overall plan is to capture most of a stock price upturn and avoid most of a price downturn. This requires both knowing when to buy and when to sell which, in turn, means having a market timing guide to use in making those decisions. The one I use is called Price Wave Analysis (PWA) and you can review the system by going to Investment Timing Software.

Arley Loeffler, Investment Timing Software

 

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