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How to profit with beta investing

/ 05:16 AM May 08, 2019

It is true that investing in stocks can be risky if you don’t know what you are doing.

But no matter how much you have prepared and carefully studied your stocks, there is always the risk that you may lose from your investments.

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Such risks may be caused by a rise in interest rates, a fall in the peso dollar exchange rate or a crash in the US market, which you may not have control over.

These types of risks, which are known in finance as systematic risks, are inherent in the market and cannot be completely avoided.

Because of this, you can only minimize the impact by limiting your exposure to market risks.

One way to reduce this risk is by allocating your investments in several stocks, ideally from different sectors, so that they are uncorrelated with each other.

When stocks are independent of each other, the negative returns that one stock may bring to your portfolio may be mitigated by another stock that reacts in the opposite direction.

Every stock has unique vulnerability to market risks. Some stocks may be highly sensitive while some may not be so susceptible.

Measuring how risky a stock is by using the beta indicator can help you evaluate and manage how much risk you want to add to your portfolio.

If you want a higher expected return from your investments, you must take on more risks. If you want to have lower risk, you must expect lower returns, too.

The beta, which is mathematically derived from a set of historical returns between a stock and the broad market index, tells us how strongly correlated a stock is with the market.

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For example, if a stock has a beta of 1.0, it simply means that the stock will have expected return of 1 percent when the PSE index rises by 1 percent.

If you just want to go with the flow without the intention of beating the market, you can simply buy stocks with the same volatility as the market.

Some stocks you can consider are Ayala Corp which has beta of 1.0, BDO (+1.0), PLDT (+1.01), BPI (+1.03), DMCI (+1.03) and SM Investments (+1.03).

But if you want to generate excess returns by outperforming the market, you must buy riskier stocks with betas greater than 1.0.

You can choose the degree of risk that you want to assume by selecting the amount of beta. For example, if a stock has a beta of 1.2, it means that it is 20 percent more volatile than the PSE index, which increases your expected return higher than the market.

Stocks you can consider under this group are Universal Robina (+1.19), SM Prime (+1.21), Aboitiz Equity (+1.29), JG Summit (+1.55) and GT Capital (+1.61).

If you have high tolerance for risk, you can buy stocks with high betas in the range of 2.0 or higher, which means that for every 1 percent gain in the market, your stock will have expected returns of 2 percent or more.

Only two stocks in the market have beta of over 2.0. These are the speculative small cap stocks, Easy Call (+2.54) and Metro Alliance (+2.55).

Remember that the beta is an indicator of volatility. High beta stocks will have larger losses when the market falls compared to those with lower beta stocks.

If you are more conservative and risk averse, you can buy less risky stocks with betas lower than 1.0. Low beta stocks tend to move slower than the market, hence, lower expected returns.

Some of the stocks that fall under this group include Robinsons Retail (+0.23), San Miguel Corp. (+0.28), First Gen (+0.34), Meralco (+0.40), LT Group (+0.43), Puregold (+0.54), Jollibee (+0.75) and Megaworld (+0.94).

There are also stocks that have negative beta, which are inversely correlated with the market. A stock with negative beta of 1.5, for example, should go up by 1.5 percent for every 1 percent decline in the market and vice versa.

Speculative stocks normally rise when the broad market corrects. Some of these negative beta stocks are Greenergy (-2.25), ISM (-0.95), Manila Bulletin (-0.95) and IRC Properties (-0.94).

While the beta can be a useful tool in assessing risk of a stock, keep in mind that the indicator is based on historical price movement. A stock’s risk profile can always change in the future.

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