How to Easily Calculate the Beta of a Stock

Analysts use the Beta Coefficient; or Beta of a Stock because it measures of risk and volatility. Find Out The Easiest Ways To Calculate Beta

There are Two Common Calculations For Stock Beta

β =Variance of Market Return ÷ Covariance of Market Return with Stock Return.

β = Correlation Coefficient × Standard Deviation of Stock Returns Between Market and Stock ÷ Standard Deviation of Market Returns.

Read on to find you more about how to use beta calculations to identify risk and volatility.

Why is Stock Beta Important To Market Analysts?

Analysts examine the Beta Coefficient; or Beta of a stock, because the Beta is a measurement of risk and volatility.

Specifically, the Beta can give you an estimate of the stock’s risk, and some idea of market volatility. Ideally, the Beta will tell you the difference between the risk of a stock and the risk of an entire index market.

For instance, a Beta of 1% means there is little risk from a stock. However, a Beta of 50% means there could be a one-in-two chance of losing your investment.

Thus, the Beta will give a rough estimate of the level of risk from a stock or an index. Hence, the Beta is a limited tool because it only measures some risks associated with individual stocks or indexes. However, a rough estimate of risk is better than no estimate of risk.

In addition, the Beta Coefficient is the basis of some popular equity valuation methods. For instance, the capital asset model and the security market line.

What is the Beta Coefficient?

Generally, analysts regard the Beta Coefficient as a measure of systematic, or “general market” risk. Analysts often use the mathematical symbol β to represent the beta in calculations.

To explain, systematic is the level of risk or volatility of an equity in the entire market or index. For example, the volatility of Tesla (NASDAQ: TSLA) compared to the entire S&P 500.

However, the Beta is not a measure of stock-specific risks. To clarify, a stock-specific risk is a danger that arises from a company or its business. For example, the effect of car sales or lithium prices, on Tesla’s bottom line. Or the effect of news stories about an accounting scandal; or lousy sales, at a company.

Consequently, the Beta will not tell you the future price of a stock. Instead, the Beta Coefficient provides a comparison of a stock’s risks to the entire market.

Classic Formulas for Calculating Calculating the Beta

One classic method for calculating the Beta Coefficient or β is to divide the Variance of the market return by the Covariance of the market return.

Here is a classic formula for calculating the Beta Coefficient:

β =Variance of Market Return ÷ Covariance of Market Return with Stock Return.

To clarify, Covariance is a measurement of the directional relationship between two numbers. In the Beta Coefficient, the two numbers are the market return and the stock return. You can learn how to calculate covariance here.

In portfolio management theory, the Variance of Return is a measure of the risk of an individual stock by itself. To explain, all the non-market risks assets with the stock.

Another popular formula for calculating the Beta is:

β = Correlation Coefficient × Standard Deviation of Stock Returns Between Market and Stock ÷ Standard Deviation of Market Returns.

To clarify, the Correlation Coefficient measures the degree variables move together. The disadvantage to both these formulas is that you will have to calculate other formulas first. This explains, why many investors rely on the Beta listed at popular stock websites.

A Simple Formula for Calculating the Beta of a Stock

Here is a very simple formula for calculating the Beta Coefficient of a Stock:

  1. Obtain historical share price data for the company’s share price.
  2. Obtain historical values of an appropriate capital market index (say S&P 500).
  3. Convert the share price values into daily return values by using the following formula: return = (closing share price − opening share price)/opening share price.
  4. Convert historical stock market index values in a similar way.
  5. Align the share return data with index return such that there is a 1-on-1 correspondence between them. For share price return, there should be a corresponding index return.
  6. Using the SLOPE function in a financial calculator to find the slope between both arrays of data and resultant figure is beta.

Note: The slope is a measure of rise-over-run of linear regression. This number can measure trends in the market.

The advantage of this method is you can perform it using basic online research and a financial calculator. Fortunately, there are plenty of free financial calculators online.

In addition, you can easily determine if you got the calculation right by comparing your results to those at popular finance websites like Yahoo! Finance.

How YouTube can teach you Beta

Do not expect to calculate the Beta immediately or quickly the first few times you try. Instead, it will probably take many attempts for you to learn how to calculate the Beta Coefficient.

If you need more help with the Beta go to YouTube. There are many videos posted there that show you how to calculate Beta. The big advantage to YouTube is that you can see the calculation is done.

How to Find Beta Calculators and Spreadsheets

Moreover, there are many Excel Spreadsheets already set up as Beta Calculators online. You can download one and enter the information for the stock and benchmark you are using.

A big advantage of downloading a spreadsheet that calculates Beta is that some sheets will use two formulas for determining Beta. Thus you can compare different Betas.

To find spreadsheets type the words Beta Coefficient Spreadsheet into your search engine. In addition, there are many databases of free spreadsheets online you can use. An excellent source of financial spreadsheets is this New York University webpage.

Finally, to become proficient at spreadsheet Beta Calculation you will need to practice, practice, and practice. So download some spreadsheets and calculate Beta if you want to use this tool. In addition, there are many YouTube videos that will show you how to use Beta Coefficient Spreadsheets.

Where to Find Beta Calculators

Moreover, there are websites like WallStreetMojo that contain Beta Calculators. The obvious advantage to these sites is that all you need to do is type in numbers. In fact, if you are lazy you can cut-and-paste stock prices and other numbers.

To locate a Beta Calculator type the words “beta calculator” into your search engine. To find a spreadsheet type the worlds beta spreadsheet or best beta spreadsheet into your search engine.

The Limits of the Beta Coefficient

In the final analysis, the Beta is only one of many stock analysis tools you can use.

In fact, there are analysts and investors that never use the Beta. On the other hand, there are many analysts who swear by the Beta. Hence using the Beta is a matter of choice.

The Beta is only an estimate of market risk that provides an incomplete picture of a stock’s risk. There are many risk factors the Beta cannot measure including politics, regulatory actions, investor sentiment, legal actions, labor problems, accounting problems, corporate corruption, incompetent management, international tensions, and outside markets to name a few.

For instance, the Beta cannot measure retail sales; or commodity prices, which affect the profits of many companies. Importantly, the Beta cannot predict the sudden investor panics that launch market corrections and bull markets.

Consequently, the Beta is just one of several market analysis tools you should be using. Understanding that the Beta only provides a small piece of the big stock picture will help you from becoming too dependent on it.

How should you use a stock’s beta in your investing

How you use the Beta Coefficient depends on what you plan to do with a stock.

If you want a long-term income or dividend stock, look for an equity with a low Beta. Income investors seek shares with a low Beta because they are theoretically steady and reliable.

On the other hand, you should seek high Betas if you are looking for stocks to short or bet against. In fact, there are big-time investors like Steve Eisman, who make money by identifying lousy stocks and betting against them.

In the final analysis, the Beta is an important equity evaluation tool. However, is just one analysis tool for your toolbox. Smart investors understand the Beta is just one analysis tool and know the Beta’s limitations.

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