As investors, we always aim to maximize our returns while minimizing risk. Beta is a powerful tool that can help us achieve both objectives by giving us an idea of how a stock will behave in relation to the general market. For that reason, it is a key variable when investing in an informed way. In this Hapi article, we explain what beta is and how to use it in your investments.

An introduction to beta

Beta is a measure of the expected movement in a financial asset (e.g., a stock) in relation to movements in the general market. Simply put, it measures the volatility of a stock (usually over the past three years). For stocks, the S&P 500 index is typically used as a benchmark.

Beta helps investors get an idea of the risk associated with a particular stock. It is an essential part of the Capital Asset Pricing Model (CAPM), which forms the foundation of portfolio theory.

How is beta interpreted?

Intuitively, this index has a beta of 1, as it reflects the expected volatility if you own all the stocks in the market. If a stock's beta is greater than 1, it will be more volatile than the market. On the other hand, if a stock's beta is less than one, it will be less volatile.

From this, we can say that stocks with a high beta are riskier but also have a higher potential return. Similarly, stocks with a low beta have lower risk but also lower returns.

Beta ValueVolatilityExamples*β = 1Equal to the marketS&P 500β >1Higher than the marketGrowth stocks0< β <1Lower than the marketEnergy or consumer staplesβ = 0UncorrelatedUnlikelyβ < 0Opposite to the marketGold mining, counter-cyclical stocks

• These cases do not always apply. It's important to personally check a stock's beta before investing to avoid wrong assumptions.

How is beta calculated?

To calculate beta, statistical regressions are needed. Investors must divide the covariance of a stock with the market by the variance of the overall market. In finance, covariance measures how two assets move in relation to each other.

This function can be easily obtained in Excel:

1. Get the weekly prices of a stock.
2. Get the weekly quotes of the S&P 500.
3. Calculate the weekly returns of the stock.
4. Calculate the weekly returns of the index.
5. Use the "slope" function and select the market and stock returns, respectively. The result is the beta of that stock.

Although this method may be a bit complex for those unfamiliar with economics or statistics, the important thing is to understand the reasoning behind it. The goal is to calculate the trend of a stock's returns in response to market movements.

Some disadvantages of using beta

Beta is based solely on past information. While it clearly shows a stock's volatility over the past three years, as an investor, you care about how it will move in the next three years.

Moreover, beta includes only quantitative data, excluding important qualitative information. If there are significant recent changes in the company's strategy, they won't be reflected in the beta.

Finally, this number is not available for companies that have not been listed on the stock market for long, such as IPOs.

That's why it's important to complement beta with current financial information that allows you to project the company's potential. Beta is just one part of your research.

In summary, beta measures a stock's volatility against market index movements. This is useful for gauging the risk of your portfolio and determining expected returns.

With knowledge of beta and other financial indicators, you can prepare to invest in the U.S. stock market. The next step is to open an account on a reliable investment platform. With Hapi, you can trade on a SEC- and FINRA-regulated app, buy stocks without commissions or minimum amounts in Latin America, and get a crypto welcome gift of up to $500. Click here to get started.