Beta factor

The beta factor describes the extent to which the price of a stock follows the development of an index – i.e., whether it performs better or worse than the market. A stock with a beta factor larger than 1 is more volatile than the market; a beta factor smaller than 1 indicates that the stock is less volatile than the market. If the beta factor is 1.2, an increase (or decrease) of 10 per cent in the index would lead to an increase (or a decrease) of 12 per cent in the stock; if the beta is 0.8, the increase (or decrease) in the stock would be 8 per cent. When there is a clear market trend, stocks can be valued on the basis of their beta factor. In a bull market, shares with a beta larger than 1 offer above-average earnings potential; in a bear market, investors are less likely to incur losses on shares with a beta smaller than 1. It is assumed that the beta factor of the previous period will apply in the future as well.

The validity of the beta factor as a performance indicator is linked to the correlation coefficient. Price movements forecast on the basis of the beta factor are more reliable as the correlation coefficient increases. While the correlation coefficient is a measure of the type of correlation between a stock and an index (positive or negative) and the likelihood of that the price of the stock will develop parallel to the index, the beta factor indicates the extent of deviation between the two.