Transcript of the Podcast
Hi This is your editor Arjun Parthasarathy speaking. The Friday podcast is a new feature for the followers of Investors are Idiots.com. The brief podcast will select one topic for analysis and will be released every Friday.
This week’s topic is on “ What is beta and how to look at it”
The sudden euphoria in equities is now throwing up talk of Sensex and Nifty at 20,000 and 6000 levels respectively by the end of fiscal 2013, an 8.5% plus gain from current levels. The so called experts are now asking you to take on high beta stocks as risk on trade increases in the market. However beta is a greatly misunderstood indicator and one has to be careful on how to use beta. Let me explain further.
Beta is the movement in a particular stock with respect to its index. The index beta is always one. A high beta stock is a stock that has a beta higher than 1 while a low beta stock has a beta less than 1. For example if Reliance beta is 1.2, for every rise or fall of 10% in the Nifty index, Reliance stock price will rise or fall by 12%. Similarly low beta stocks like Asian Paints that has a beta of 0.35, will rise or fall much less than the Nifty rise or fall. If Nifty rises by 100%, Asian Paints is expected to rise by only 35% while if Nifty falls by 50%, Asian Paints will fall by 17.5%.
In rising markets experts tell you to buy high beta stocks to outperform the index while in falling markets experts tell you to buy low beta stocks. The main issue here in using beta to outperform markets is that a fundamental expected move in an index is being clubbed with a technical indicator that is beta.
Beta values are derived from past movement in markets and stock prices. As you must have by now realized, past movements are the worst indicator of future movements. A trader following only technical analysis blindly can use beta for the extreme short term (say a hour or a day) beta may live up to its values. But in the long term, beta is not an indicator for investors to follow.
The example of Asian Paints says it all. Asian Paints has returned over 280% over the last five years and the Nifty has just returned around 12%. The beta of Asian Paints at 0.35 is completely misleading looking at the last five years performance. There were many fundamental factors going positive for Asian Paints, making it a huge outperformer over the Nifty and those fundamentals are not captured in beta.
The bottom line on beta is leave it to the experts and you follow the fundamentals that you understand while investing.
Thank you for listening in. Have a good weekend.