I really like to find stocks that tend to outperform the SP500 during up trends; stocks that tend to outperform during up markets show strong relative strength. However, stocks that outperform during rallies tend to carry inherently more risk for their potential reward. An important concept for understanding the risk of a particular stock is knowing what its Beta is. A stock's Beta is basically its relationship (performance) vs. the SP500 over a long period of time. More risky stocks tend to have higher Beta and safer stocks have lower Beta. A stock with a higher beta (>1) will outperform the market during rallies and under perform during declines. A lower beta stock (<1) will under perform during rallies but with outperform during declines. Understanding beta is a very important concept when it comes building and managing your investments. If you are building a portfolio of stocks you need to identify what the primary purpose of your investments will be. Are you investing for growth? For value? For dividends? Understanding the proper asset for each investment plan is absolutely critical to achieve the results you desire.
If you are relatively young (under 40) and looking to put away some savings hoping it will grow fast then you will need to create a high beta portfolio. If you are over 50, nearing retirement, and hoping to maintain what you currently have, then low beta dividend positions would be right for you. The nice thing about understanding beta is that you can also mix and match them in a portfolio. You may choose to invest in some higher beta positions while hedging those riskier assets with some lower beta holdings. That way when the market goes up, part of your portfolio will outperform. When the market takes a hit you will lose some with the higher risk holdings, but the other portion of lower beta assets will hold up much better.
Quantifing the effect of beta vs SP500 performance
When you are looking through assets for higher or lower beta you will find that rarely are they nice round numbers. The important thing to know about determining high or low beta is how far from 1 the asset's beta is. For example a stock with a beta of 2 will move twice as fast as the SP500 on average. Therefore if the SP500 is up 1% on the day, we would expect the 2 beta stock to be up close to 2%. On the flip side of that, if the market is down 1%, our stock would be down about 2%. So you can see the inherent risk/reward with higher beta stocks. The SP500 has a beta of 1; 1 is the constant for "market perform" or matching the return of the SP500. A stock with a beta of 1 will be expected to perform equal to the market. A stock with a beta of .5 will return about half of the SP500, which is great if the market is down 5%, but not as much if the market is up 5%. Your .5 beta stock would be down 2.5% and up 2.5% respectively.
High and Low Beta Stocks
High Low
DDD 2.05 HAIN 0.3
MOS 1.55 AAPL 0.74
F 1.55 ENB 0.46
WFC 1.23 HD 0.99
CMI 1.74
This is the beta list for our watch list stocks. The beta for any other stock can easily be found on Yahoo Finance or any other reputable business news website.
Most of the higher paying dividend stocks have lower beta:
T 0.39
AEP 0.33
PFE 0.74
AGNC 0.24
While other riskier stocks tend to have higher beta
BBRY 1.54
SSYS 1.53
FB 1.70
Beta doesn't guarantee an exact result in relationship to market performance, but it does give us some idea as to how a particular investment should behave. Investing only in Beta is a terrible way to build a portfolio, however it is another important concept for understanding the risk you are exposing yourself and your savings to.
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