- Beta ratings offer a way to determine how safe or how risky a stock is. Stocks with higher than average beta ratings are considered riskier than stocks with lower than average beta ratings. This is because high-beta stocks experience wider swings than low-beta stocks. With greater risk, however, comes greater potential reward. High-beta stocks make greater gains when the markets are trending higher. Contrarily, low-beta stocks tend to lose significantly less money when markets are trending lower.
- Theoretically, a high beta stock is considered risky. Value investors, such as Warren Buffet, may disagree. Value investors look to buy stocks that are low in price compared to earnings. Thus, when a high beta stock has fallen significantly, according to value investors, the price may be cheap in comparison to its earning potential and thus represents a low-risk opportunity to buy.
- Financial industry experts often point out that past performance is not a reliable predictor of future performance. Beta is calculated based on a stock's past performance. Beta ratings cannot account for industry shifts and new lines of business, which have the potential to create new demand for the stock. For example, Walmart stock had high beta ratings when it was a young, small company. As it expanded and took over market share, beta ratings dropped as it became a less risky investment.
- Price volatility is one way to measure risk in the market, but it doesn't cover all potential risks. Take the company Enron, for example. It once had a beta rating below one, indicating it was less risky to own than stocks with higher ratings. However, as information emerged that it was engaged in illegal accounting practices, the price of the stock plummeted.
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