In this post we are going to discuss the unicorn of negative beta and how that relates to how we invest and what we are seeing in GameStop stock right now.
What Is Beta?
The value of any stock index, such as the Standard & Poor’s 500 Index, moves up and down constantly. At the end of the trading day, we conclude that “the markets” were up or down. An investor considering buying a particular stock may want to know whether that stock moves up and down just as sharply as stocks in general. It may be inclined to hold its value on a bad day or get stuck in a rut when most stocks are rising.
The beta is the number that tells the investor how that stock acts compared to all other stocks, or at least in comparison to the stocks that comprise a relevant index.
Beta measures a stock’s volatility, the degree to which its price fluctuates in relation to the overall stock market. In other words, it gives a sense of the stock’s risk compared to that of the greater market’s. Beta is used also to compare a stock’s market risk to that of other stocks. Analysts use the Greek letter ‘ß’ to represent beta.
Beta is calculated using regression analysis. A beta of 1 indicates that the security’s price tends to move with the market. A beta greater than 1 indicates that the security’s price tends to be more volatile than the market. A beta of less than 1 means it tends to be less volatile than the market.
Essentially, beta expresses the trade-off between minimizing risk and maximizing return. Say a company has a beta of 2. This means it is two times as volatile as the overall market. We expect the market overall to go up by 10%. That means this stock could rise by 20%. On the other hand, if the market declines 6%, investors in that company can expect a loss of 12%.
If a stock had a beta of 0.5, we would expect it to be half as volatile as the market: A market return of 10% would mean a 5% gain for the company.
Here is a basic guide to beta levels:
Negative beta: A beta less than 0, which would indicate an inverse relation to the market, is possible but highly unlikely. Some investors argue that gold and gold stocks should have negative betas because they tend to do better when the stock market declines.
A beta of -1 is a perfect negative correlation, so the stock moves exactly the opposite of the market, e.g. if market goes down 10%, the stock goes up 10%.
A beta of less than -1 means this negative correlation is amplified, e.g. market goes down 10%, stock goes up 15%.
Beta between 0 and 1: Companies that are less volatile than the market have a beta of less than 1 but more than 0. Many utility companies fall in this range.
Beta of 1: A beta of 1 means a stock mirrors the volatility of whatever index is used to represent the overall market. If a stock has a beta of 1, it will move in the same direction as the index, by about the same amount. An index fund that mirrors the S&P 500 will have a beta close to 1.
Beta greater than 1: This denotes a volatility that is greater than the broad-based index. Many new technology companies have a beta higher than 1.
Beta greater than 100: This is impossible, as it indicates volatility that is 100 times greater than the market. If a stock had a beta of 100, it would go to 0 on any decline in the stock market. If you see a beta of over 100 on a research site it is usually a statistical error or the stock has experienced a wild and probably fatal price swing. For the most part, stocks of established companies rarely have a beta higher than 4.
Why Beta Is Important
Are you prepared to take a loss on your investments? Many people are not and they opt for investments with low volatility. Others are willing to take on additional risk for the chance of increased rewards. Every investor needs to have a good understanding of their own risk tolerance, and a knowledge of which investments match their risk preferences.
Using beta to understand a security’s volatility can help you choose the securities that meet your criteria for risk.
Investors who are very risk-averse should put their money into assets with low betas, such as utility stocks and Treasury bills. Investors who are willing to take on more risk may want to invest in stocks with higher betas.
Where to Find the Beta Number
Yahoo! Finance is among the websites that publish beta numbers. Enter the company name or symbol in the search field, then click on “Statistics.” You’ll find the beta listed under “Stock Price History.” The beta on Yahoo! compares the activity of the stock over the last five years to that of the S&P 500 Index. For example, as of Oct. 27, 2020, the beta for Microsoft (MSFT), as found on Yahoo! Finance, is 0.92.
A beta of “0.00” on Yahoo! Finance means that the stock is either a new issue or doesn’t yet have a beta calculated for it.
Warnings About Beta
The biggest drawback to using beta to make an investment decision is that beta is a historical measure of a stock’s volatility. It can show you the pattern so far but it can’t tell you what’s going to happen in the future.
The second caveat for using beta is that it is a measure of systematic risk, which is the risk that the market faces as a whole. The market index to which a stock is being compared is affected by market-wide risks. So, beta can only take into account the effects of market-wide risks on the stock. The other risks the company faces are specific to the company.
About GME specifically
Here is the historical beta of GME from Zacks:
You can see that GME’s beta has only been negative since end of Feb 2021. Before that it had a very normal beta of over 1, meaning when the market was doing well, then its business did well too, i.e. people have money to spend on games, etc. Even during most of the lockdown its beta was still quite a bit above 1. But at the end of Feb, it suddenly went all the way down to -2.195. What happened at that time? The massive crash down to $38. Depending on the source, we see: (Financial Times: -1.7413, Yahoo Finance: -2.07, Nasdaq: -2.09, Bloomberg: -8).
What are we to make of all this? Well, what we are seeing is the unicorn of negative beta in GameStop currently.
Many publications note that negative betas may be a once in a 100-year event because they are just that rare. What we are seeing today in GameStop illustrates just how unique of a situation we are in currently, much like the fabled unicorn.
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