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How Beta Helps You Find Undervalued Shares?

Their are a number of methods to find undervalued stocks and one of the factor is the beta of the stock. As a layman we can define that Beta measures the systematic risk in a stock by measuring the volatility in the price of a stock relative to the overall market.

  • The market index is assumed to have a beta of 1.
  • Stocks with a beta greater than one are likely to be riskier than the market. Stocks with beta less than one are less risky than the market.

The logic of this method is that if the price of a stock is more volatile than the market index itself, then it is more impacted by systematic risk than the average market.

Such stocks tend to rise more than the market during a bull period and decline more than the market average during bearish periods.

A high beta is associated with riskier growth stocks. Equity stocks that move up quickly when the economy is doing well and decline rapidly during periods of low economic growth are known as cyclical stocks.

A low beta is associated with defensive stocks. Defensive stocks belong to companies that are relatively insulated from economic cycles. Consumption of items of daily use and medicines is not likely to be affected by market cycles, but remain steady. Stocks from consumer goods, drugs and pharmaceuticals, health care sectors tend to feature low systematic risk.

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