Statistical and Graphical Example

Example 7: A word on stock beta coefficients

 

The table below gives some recent stock beta coefficients for various stocks. A stock's beta coefficient is obtained from the regression,

                                       y = a + bx + e  

where y = the dependent variable of stock returns and x = the independent variable of returns on the market. The intercept = a and indicates the value of y should the independent variable equal zero or if b = 0. The stock's beta is given by the coefficient, b and is the slope of the regression line. The term "e" is a residual term intended to capture any variation in y not explained by the regression model. Note, the y and x variables are given and the a and b terms are estimated from the regression. 

The slope (beta) shows the sensitivity of the return variable y to changes in the market return x. As such beta is a measure of the risk of the stock assuming the investor is well-diversified. Therefore beta measures only market risk; all other risk is assume to have been diversified away.

High betas indicate high risk.  These stocks will have a higher required rate of return. Low beta stocks indicate lower risk and will have lower required rates of return. Keep in mind that stock betas change over time and depend upon the type of market index you are using as the x variable.

Now on to the table of betas below for May 2010 as determined from Valueline Investment Survey (also available at the Tarleton library).

At this time BOA had the highest beta of 1.85. This means that a 10% change in the market would lead to an 18.5% increase in BOA stock; likewise a 10% decline in the market would lead to an 18.5% decline in the return of BOA. So BOA is a risky situation as are most financial stocks today. At the bottom of this list are Heinz, Coke, and P&G. These companies sell everyday staple items. They will have stable sales irrespective of the market being up or down. Of course, they will not have spectacular ups when the market is up or big dips when the market is down.

 

return to top | previous page | next page