“This stock is highly volatile. Is this company more risky than the broad market?” Quotes like these are seen or heard when we are going through the newspaper or watching any business channel. How do we conclude if a company is riskier than the market? If it is riskier than the market then it should also yield a higher return – as risk and return are positively correlated.

Market Risk – If there is a global recession (something that is going to impact the market as a whole) then all the companies will be affected by it. This was witnessed by the world economy in years 2007-09. A recession has a varying degree of impact on different companies. Following Data explains this further.

The data shows annual returns of two companies Tata Steel and Cipla, along with the annual returns of Nifty (NSE – Benchmark Index). Observe the returns for each company in accordance with Nifty. When Nifty goes up, both Tata Steel and Cipla go up. When Nifty comes down, both the stocks come down. However the magnitude of movement of each stock is different. Tata Steel gives higher returns than nifty during the positive phase and higher negative returns than the nifty in the negative phase, vice versa in case of Cipla. Movements of Cipla are less in tandem with the Nifty.

Above illustration shows that the market risk is compensated for by additional returns on risky companies (case in point – Tata Steel).

This market risk will be applicable to all the stocks in the market. Thus there should an indicator which measures this market risk. This indicator is termed as “Beta” in finance.

Definition: The Beta (β) of a stock or portfolio is a number describing the relation of its returns with those of the financial market as a whole.

A stock has a Beta of zero if its returns change independently of changes in the market’s returns. A positive beta means that the asset’s returns generally follow the market’s returns.  A negative beta means that the asset’s returns generally move opposite the market’s returns: one will tend to be above its average when the other is below its average.

Beta measures the non-diversifiable risk or the market risk or systematic risk. Beta can be estimated for individual companies using regression analysis against a stock market index. The statistical formula for calculation of beta is as given below:

Where to get the Beta values?

Beta for public listed companies are available on the select websites like,

Click on the link provided to see the beta value of Cipla and Tata Steel

Following are the beta values of the two stocks:

Discussion – Cipla: As expected Cipla has a lower Beta value as it’s business is less correlated with the overall economy. A recession will have low effect on the number of people falling ill or needing health assistance. Thus the healthcare sector is not impacted by market movements and it shows low correlation with the market movements. This is the reason why it has a lower value of beta. It also suggests lower risk and hence lower returns. As a result this sector is regarded as a defensive sector. A good investment bet when market’s start a downward rally.

Discussion – Tata Steel: Steel is a cyclical industry. It is heavily dependent on the movement of the economy. Following flowchart explains the major drivers for the Steel Industry.

As a result the movement of the Tata Steel stock magnifies the market movements. This gets appropriately captured in Beta value. Hence steel is a cyclical sector. As the steel cycle turns positive the fortunes of the steel companies change and they start reporting robust earnings performance and the stocks move up giving higher returns.

Next Reading

Stay tuned for the next post on: Calculating Beta for Indian Companies in Excel

About The Author

Sameer, has an extensive experience in the financial services, consulting and training domain. He has extensive knowledge of the financial services industry, where he has analyzed companies in the Business Services, Metals and Mining and Retail Companies, for the North American Markets and Canadian Geographies. In the Indian markets he has worked in Project Finance in the Infrastructure and Power Sectors.

He has authored research papers and trained 1000′s of senior people in the area of financial modeling, quantitative analysis and risk management. He holds a MBA degree from NITIE and is CFA Level III candidate.