For Protean Energy Limited’s (ASX:POW) shareholders, and also potential investors in the stock, understanding how the stock’s risk and return characteristics can impact your portfolio is important. Broadly speaking, there are two types of risk you should consider when investing in stocks such as POW. The first type is company-specific risk, which can be diversified away by investing in other companies to reduce exposure to one particular stock. The second risk is market-wide, which arises from investing in the stock market. This risk reflects changes in economic and political factors that affects all stocks.
Different characteristics of a stock expose it to various levels of market risk. The most widely used metric to quantify a stock’s market risk is beta, and the market as a whole represents a beta of one. Any stock with a beta of greater than one is considered more volatile than the market, and those with a beta less than one is generally less volatile.
Check out our latest analysis for Protean Energy
What does POW’s beta value mean?
Protean Energy’s beta of 0.49 indicates that the company is less volatile relative to the diversified market portfolio.This means that the change in POW’s value, whether it goes up or down, will be of a smaller degree than the change in value of the entire stock market index.Based on this beta value, POW appears to be a stock that an investor with a high-beta portfolio would look for to reduce risk exposure to the market.
How does POW’s size and industry impact its risk?
A market capitalisation of AUD $4.62M puts POW in the category of small-cap stocks, which tends to possess higher beta than larger companies. Furthermore, the company operates in the capital goods industry, which has been found to have high sensitivity to market-wide shocks. Therefore, investors may expect high beta associated with small companies, as well as those operating in the capital goods industry, relative to those more well-established firms in a more defensive industry. It seems as though there is an inconsistency in risks portrayed by POW’s size and industry relative to its actual beta value. There may be a more fundamental driver which can explain this inconsistency, which we will examine below.
Can POW’s asset-composition point to a higher beta?
During times of economic downturn, low demand may cause companies to readjust production of their goods and services. It is more difficult for companies to lower their cost, if the majority of these costs are generated by fixed assets. Therefore, this is a type of risk which is associated with higher beta.I test POW’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint.Given that fixed assets make up less than a third of the company’s total assets, POW doesn’t rely heavily upon these expensive, inflexible assets to run its business during downturns.As a result, the company may be less volatile relative to broad market movements, compared to a company of similar size but higher proportion of fixed assets. Similarly, POW’s beta value conveys the same message.
What this means for you:
Are you a shareholder? You may reap the benefit of muted movements during times of economic decline by holding onto POW. Its low fixed cost also means that, in terms of operating leverage, its costs are relatively malleable to preserve margins. I recommend analysing the stock in terms of your current portfolio composition before increasing your exposure to the stock.
Are you a potential investor? Before you buy POW, you should look at the stock in conjunction with their current portfolio holdings. POW may be a great cushion during times of economic downturns due to its low beta and low fixed cost. However, in addition to this, I recommend taking into account its fundamentals as well before jumping into the investment.
Beta is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Protean Energy for a more in-depth analysis of the stock to help you make a well-informed investment decision. But if you are not interested in Protean Energy anymore, you can use our free platform to see my list of over 50 other stocks with a high growth potential.
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