Growth investors and investors with high-risk tolerance may be interested in high-growth, high-beta stocks. High-beta stocks can generate high returns but also have significant downside risks when markets fall. Understanding beta and its uses can be important for growth investors seeking to identify the best-performing stocks.
Key Takeaways
- High beta stocks are positively correlated with returns of the S&P 500, but at an amplified magnitude.
- These stocks outperform in bull markets but can underperform in bear markets.
- High beta stocks are often small to mid-cap stocks that are maturing with significant volatility around new announcements and trends.
Understanding Beta
Beta is a statistical measure of a stock's relative volatility to the broader market, typically the S&P 500, where it can measure risk. A stock's beta is found through regression analysis that infers the correlation in price changes in the stock to the S&P 500. A beta of 1.0 indicates that a stock’s volatility is parallel to the market and will often move in tandem with the index and at the same magnitudes.
A beta above 1.0 means the stock will have greater volatility than the market, and a beta less than 1.0 indicates lower volatility. Volatility is usually an indicator of risk, and higher betas mean higher risk, while lower betas mean lower risk. Stocks with higher betas may gain more in upward markets but lose more in downward markets.
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Covariance is the measureofastock’sreturnrelative tothatofthemarket. Variance is the measureofhowthemarketmovesrelative toitsmean.
Investing in High-Beta Stocks
High-beta stocks can be great investments in bull markets since they are expected to outperform the S&P 500 but require a great deal of active management because of their market sensitivity. These are highly volatile and risky investments in isolation. In a bear market reversal, stocks can be expected to lose the most. High-beta stocks are generally not long-term buy-and-hold investments.
For growth in a portfolio, an investor will likely choose stocks with a beta above 1, providing a greater chance of a higher return for assuming the higher risk of losing value when the market goes down. Investors can hedge this volatility by adding a variety of stocks close to 1, depending on theirrisk tolerance. Investors who predict the market to move downward will also look at stocks with negative betas.
Examples of High-Beta Stocks
As of February 2023, these three stocks have betas around 2.0 and are members of the S&P 500 index.
Advanced Micro Devices (AMD)
AMD is a semiconductor company that makes chipsets and microchips, competing with Intel and Qualcomm. As of February 2023, its market cap was $126.57 billion. The company is riskier than most S&P 500 stocks, with a beta of 1.98.
NVIDIA Corporation (NVDA)
Nvidia Corporation is an American multinational technology company founded in 1993, incorporated in Delaware, and based in Santa Clara, California. As of February 2023, its market cap was $532.99 billion, and its beta was 1.79.
ETSY, Inc. (ETSY)
Etsy is the global marketplace for unique and creative goods, connecting buyers and sellers from nearly every country. As of February 2023, Etsy's market cap was $16.3 billion and had a beta of 1.86.
Limitations and Risks of High-Beta Stocks
An investor will need more information than beta to assess whether a stock belongs in the portfolio. Beta does not account for trends or news events that may impact a stock. Stocks with high betas are more volatile than the overall market, and beta does not predict the direction of a stock's price or consider the company's strength.
What Does a High Beta Tell Investors?
A stock that moves more than the market over time has a beta greater than1.0. If a stock moves less than the market, the stock's beta is less than 1.0. High-beta stocks tendto be riskier but provide thepotential for higher returns. Low-beta stocks pose less risk but typically yieldlower returns.
How Does Beta Measure Risk?
Beta is often used as a risk-reward measure, meaning it helps investors determine how much risk they are willing to take to achieve a returnfor taking onthat risk.
How Does Beta Correspond to the S&P 500 Index?
The beta of the S&P 500 is 1. A stock that is highly correlated to the S&P 500 will also have a beta of 1. If the S&P 500 index is up in daily trading, the stock is most likely going to be up for that day.
The Bottom Line
High-beta stocks require active management. They are also often small to mid-cap stocks maturing with significant volatility around new announcements and trends. Investing in high-growth, high-beta stocks come with high risks, so investors often seek to balance them with lower-risk portfolio holdings and cash liquidity.
