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Stock Screen: Beta Testing and Your Portfolio - March 9, 2012
Those who prefer a top down approach to investing will likely want to pay particular attention to the betas of their holdings. An investor who feels greater conviction in his/her outlook toward the broader market, than in their stock-selection prowess, is likely to find this statistic to be a particularly useful tool when constructing and monitoring his/her portfolio. On each Value Line report, the beta of a stock can be found on the top left part of the page, just below our Timeliness, Safety, and Technical ranks. In lay person terms, beta is a measure of the degree to which a stock’s price changes in relation to movements in the broader market.
By finding the weighted average beta of their portfolio, investors should be able to get a sense of how their investments are likely to respond, in the aggregate, to various market conditions. For instance, a portfolio weighted toward stocks with betas below 1.00 would be expected to exhibit less volatility than the broader market. Last fall, we used the Value Line stock screener to review some total-return data and found that, as expected, a low-beta portfolio would have helped investors to limit their losses during the turbulent conditions that characterized the market during the summer of 2011.
In view of the decidedly different tone of the market of late, we have decided to revisit this issue and evaluate how high- and low-beta stocks fared more recently. To do so, we used Value Line’s stock screen tool to create two hypothetical portfolios using beta as the key variable and then compared their respective performances over the past three months.
To qualify for inclusion in our low beta portfolio, a stock had to have a beta of 0.65 or below, while the high beta portfolio was comprised of equities with betas of 1.75 or above. This resulted in two groups of roughly 80 stocks each.
The data once again indicates a high correlation between a stock’s beta and its relative share price performance compared to the broader market. As would be expected, the high-beta portfolio took top honors this time. The median return for this group was about 25%. In comparison, the roughly 10% advance by the S&P 500 Index over the same stretch looks fairly pedestrian.
A sizable number of industries are represented in the high-beta group. Those whose prospects are most closely tied to the macroeconomic environment are most represented. Auto stocks were in abundance, for instance. Four of these equities, American Axle (AXL), Dana Holding (DAN), Tenneco (TEN), and TRW Automotive (TRW), produced total returns in excess of 30% over the past three months. Hotel & Gaming was also well represented, and three of these stocks, Gaylord Entertainment (GET), MGM Resorts (MGM), and Orient-Express (OEH), were able to eclipse the 30% mark.
On the other hand, evidence of the recent run-up in equity prices was fairly modest in the low-beta group. The median total return for this group over the past three months was below 5%. The low-beta portfolio consisted primarily of the shares of established companies operating in relatively noncyclical industries, such as electric utilities and food processing.
In view of this data, investors with a strong conviction that equity prices are poised for further gains will likely want to check that the weighted average beta of their holdings is comfortably above 1.00. On the other hand, those concerned that valuations have become overextended may wish to shift more of their assets into low-beta equities. Investors, though, should keep in mind that beta is positively correlated with volatility, meaning that a high-beta portfolio would likely be inappropriate for more conservative accounts.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.