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Beta is a measure of a stock’s systematic, or market, risk, and offers investors a good indication of an issue’s volatility relative to the overall stock market. The market beta is set at 1.00, and a stock’s beta is calculated by Value Line, based on past stock-price volatility. If an equity has a beta of 1.00, it will probably move in lock step with the broader market. For example, if the market rises (falls) by 10%, an issue with a beta of 1.00 will probably increase (decrease) by about the same amount. A beta above 1.00 indicates that a stock’s volatility is greater than the market. For instance, an issue with a beta of 1.30 has a level of volatility 30% greater than the market average. Hence, given a 10% increase (decrease) in the stock market, our hypothetical issue will probably climb (fall) about 13%. The reverse is also true. A stock with a beta of .70 has lower volatility than the overall market, and a broad increase (decrease) of 10% would likely result in a 7% gain (loss) for our low-beta issue.

Betas tend to vary across companies and industries. Stocks of large companies with numerous operating segments, such as Hewlett-Packard (HPQ), tend to have betas close to 1.00, as demand for their products tends to increase or decrease in line with aggregate economic expansion or contraction. Defensive stocks that generate relatively consistent earnings regardless of the economic climate typically have lower betas. For example,Abbott Laboratories (ABT), a pharmaceutical and healthcare company, has a beta of .60, 40% lower than the market. Demand for the company’s products is inelastic, making it hard for people to stop buying them or find substitutes. All of this leads to a relatively steady earnings stream and the stock’s lower level of volatility. Conversely, companies in cyclical industries typically have higher betas. AMR Corporation (AMR), which owns American Airlines, has a beta of 1.65, 65% higher than the market average. When the economy slows, demand for travel and other such luxuries tends to decline dramatically, and vice versa, resulting in more volatile earnings and share-price movements.

Conservative investors will likely favor stocks with low betas in order to limit volatility. However, investors need to remember that beta is a double-edged sword. Issues with low betas won’t fall as much as the broader market on the way down, but when the market rallies, they will likely be relative underperformers.

 

Company

Ticker

Industry

Beta

       

Abbott Laboratories

ABT

Drug

0.60

NYSE Composite Index

   

1.00

Hewlett-Packard

HPQ

Computers/Peripherals

1.00

AMR Corporation

AMR

Air Transport

1.65

       

All data as of 10/09/09