Published December 14th, 2018 by Josh Arnold
Spreadsheet data updated weekly, constituents updated quarterly
In the world of investing, volatility matters.
Investors are reminded of this every time there is a downturn in the broader market and individual stocks that are more volatile than others experience enormous swings in price in both directions. That volatility can increase the risk in an individual’s stock portfolio relative to the broader market.
The volatility of a security or portfolio against a benchmark – is called Beta. In short, Beta is measured via a formula that calculates the price risk of a security or portfolio against a benchmark, which is typically the broader market as measured by the S&P 500.
It is helpful in understanding the overall price risk level for investors during market downturns in particular. The higher the Beta value, the more volatility the stock or portfolio should exhibit against the benchmark. This can be beneficial for those investors that prefer to take a bit more risk in the market as stocks that are more volatile – that is, those with higher Beta values – should outperform the benchmark (in theory) during bull markets.
However, Beta works both ways and can certainly lead to larger drawdowns during periods of market weakness. Importantly, Beta simply measures the size of the moves a security makes.
High Beta stocks are not a sure bet during bull markets to outperform, so investors should be judicious when adding high Beta stocks to a portfolio, as the weight of the evidence suggests they are more likely to underperform during periods of market weakness.
However, for those investors interested in adding a bit more risk to their portfolio, we’ve put together a list to help investors find the best high beta stocks.
Additionally, you can see the 100 highest Beta stocks in the S&P 500 in the table below.
Table of Contents
- High Beta Stocks Versus Low Beta Stocks
- How To Calculate Beta
- Beta & The Capital Asset Pricing Model (CAPM)
- Analysis On 5 Of The Best High Beta Stocks
- Final Thoughts
High Beta Stocks Versus Low Beta
Intuitively, it would make sense that high Beta stocks would outperform during bull markets. After all, these stocks should be achieving more than the benchmark’s returns given their high Beta values. While this can be true over short periods of time – particularly the strongest parts of the bull market – the high Beta names are generally the first to be sold heavily by investors.
This excellent paper from the CFA Institute theorizes that this is true because investors are able to use leverage to bid up momentum names with high Beta values and thus, on average, these stocks have lower prospective returns at any given time. In addition, leveraged positions are among the first to be sold by investors during weak periods because of margin requirements or other financing concerns that come up during bear markets. In other words, while high Beta names may outperform while the market is strong, as signs of weakness begin to show, high Beta names are the first to be sold and generally, much more strongly than the benchmark.
Indeed, evidence suggests that during good years for the market, high Beta names capture 138% of the market’s total returns. In other words, if the market returned 10% in a year, high Beta names would, on average, produce 13.8% returns. However, during down years, high Beta names capture 243% of the market’s returns. In a similar example, if the market lost 10% during a year, the group of high Beta names would have returned -24.3%. Given this relatively small outperformance during good times and vast underperformance during weak periods, it is easy to see why we prefer low Beta stocks. While low Beta stocks aren’t a vaccine against downturns in the market, it is much easier to make the case over the long run for low Beta stocks versus high Beta given how each group performs during bull and bear markets.
How To Calculate Beta
The formula to calculate a security’s Beta is fairly straightforward. The result, expressed as a number, shows the security’s tendency to move with the benchmark.
In other words, a Beta value of 1.00 means that the security in question should move virtually in lockstep with the benchmark. A Beta of 2.00 means moves should be twice as large in magnitude while a negative Beta means that returns in the security and benchmark are negatively correlated; these securities tend to move in the opposite direction from the benchmark. This sort of security would be helpful to mitigate broad market weakness in one’s portfolio as negatively correlated returns would suggest the security in question would rise while the market falls.
For those investors seeking high Beta, stocks with values in excess of 1.3 would be the ones to seek out. These securities would offer investors at least 1.3X the market’s returns for any given period.
Here’s a look at the formula to compute Beta:
The numerator is the covariance of the asset in question while the denominator is the variance of the market. These complicated-sounding variables aren’t actually that difficult to compute.
Here’s an example of the data you’ll need to calculate Beta:
- Risk-free rate (typically Treasuries at least two years out)
- Your asset’s rate of return over some period (typically one year to five years)
- Your benchmark’s rate of return over the same period as the asset
To show how to use these variables to do the calculation of Beta, we’ll assume a risk-free rate of 2%, our stock’s rate of return of 14% and the benchmark’s rate of return of 8%.
You start by subtracting the risk-free rate of return from both the security in question and the benchmark. In this case, our asset’s rate of return net of the risk-free rate would be 12% (14% – 2%). The same calculation for the benchmark would yield 6% (8% – 2%).
These two numbers – 12% and 6%, respectively – are the numerator and denominator for the Beta formula. Twelve divided by six yields a value of 2.00, and that is the Beta for this hypothetical security. On average, we’d expect an asset with this Beta value to be 200% as volatile as the benchmark. Thinking about it another way, this asset should be about twice as volatile than the benchmark while still having its expected returns correlated in the same direction. That is, returns would be correlated with the market’s overall direction, but would return double what the market did during the period. This would be an example of a very high Beta stock and would offer a significantly higher risk profile than an average or low Beta stock.
Beta & The Capital Asset Pricing Model
The Capital Asset Pricing Model, or CAPM, is a common investing formula that utilizes the Beta calculation to account for the time value of money as well as the risk-adjusted returns expected for a particular asset. Beta is an essential component of the CAPM because without it, riskier securities would appear more favorable to prospective investors as their risk wouldn’t be accounted for in the calculation.
The CAPM formula is as follows:
The variables are defined as:
- ERi = Expected return of investment
- Rf = Risk-free rate
- βi = Beta of the investment
- ERm = Expected return of market
The risk-free rate is the same as in the Beta formula, while the Beta that you’ve already calculated is simply placed into the CAPM formula. The expected return of the market (or benchmark) is placed into the parentheses with the market risk premium, which is also from the Beta formula. This is the expected benchmark’s return minus the risk-free rate.
To continue our example, here is how the CAPM actually works:
ER = 2% + 2.00(8% – 2%)
In this case, our security has an expected return of 14% against an expected benchmark return of 8%. In theory, this security should vastly outperform the market to the upside but keep in mind that during downturns, the security would suffer significantly larger losses than the benchmark. Indeed, if we changed the expected return of the market to -8% instead of +8%, the same equation yields expected returns for our hypothetical security of -18%. This security would theoretically achieve stronger returns to the upside but certainly much larger losses on the downside, highlighting the risk of high Beta names during anything but strong bull markets. While the CAPM certainly isn’t perfect, it is relatively easy to calculate and gives investors a means of comparison between two investment alternatives.
Analysis On 5 Of The Best High Beta Stocks
Now, we’ll take a look at five stocks that offer investors high Beta scores as well as attractive prospective returns.
NVIDIA Corporation
The first stock we’ll look at is NVIDIA Corporation (NVDA). NVIDIA is a semiconductor company that designs and manufactures graphics processors, chipsets and related software. The company serves the gaming, artificial intelligence and autonomous vehicle markets, in addition to many others. NVIDIA pays a very small dividend, so it isn’t an income stock, but it does offer investors ~15% annual returns looking forward. We see this strong performance accruing from 15% average annual earnings growth while the fair valuation and very low dividend yield make up less than 1% of additional returns. NVIDIA’s 5-year Beta score is 2.0, making it one of the higher Beta stocks in our list. Click here to see a Sure Analysis report on NVIDIA.
Ameriprise Financial
Ameriprise Financial (AMP) is a wealth and asset management company that offers investors a unique mix of value, growth and yield. The company continues to enjoy strong inflows of capital from its customers, which is driving revenue and earnings higher. In addition, it is very shareholder-friendly, allocating the vast majority of earnings to dividend payments and share repurchases, collectively. We expect Ameriprise to deliver high-teens total returns in the years to come, consisting of 8% earnings growth, the current 3% yield and a mid-single digit tailwind from a higher valuation. Ameriprise’s 5-year Beta value is 1.8. Click here to see a Sure Analysis report on Ameriprise Financial.
Tiffany & Co.
Next up is Tiffany & Co. (TIF), the famous jewelry maker that traces its roots to 1837. The company has produced strong revenue growth numbers in recent quarters, something we expect can continue to drive the top line higher. In addition, the company’s margin expansion efforts have been working to help drive earnings higher. We expect total annual returns moving forward of about 9%, consisting of the 2.5% dividend yield, essentially no impact from the valuation, and 6% to 7% earnings growth annually. Tiffany’s 5-year Beta value is 1.7. Click here to see a Sure Analysis report on Tiffany & Co.
Norwegian Cruise Line Holdings
Norwegian Cruise Line Holdings (NCLH) is a global cruise line operator that has 16 ships in service and was founded in 1967. The company’s impressive earnings growth in recent years has been due to very strong demand for cruises industrywide and given forecasts from management for that to continue, we expect robust 8% earnings growth annually in the years to come. This, combined with a very low valuation, should produce mid-teens total returns annually in the years to come despite the fact that Norwegian doesn’t pay a dividend. Norwegian’s 5-year Beta value is 1.7. Click here to see a Sure Analysis report on Nowergian Cruise Line Holdings.
Applied Materials
Our last stock is Applied Materials (AMAT), a semiconductor company that competes with another stock in this list, NVIDIA. Applied Materials has experienced spectacular rates of growth in recent years but some cautious guidance from the company in 2018 has caused the stock to slump. However, we see strong demand from its DRAM business as helping to drive 9% annual earnings growth in the coming years. Combined with the current 2.3% yield and a ~10% tailwind from a higher valuation, we see Applied Materials as producing more than 20% annual total returns in the coming years. Applied Materials’ 5-year Beta value is also 1.7. Click here to see a Sure Analysis report on Applied Materials.
Final Thoughts
Investors must take risk into account when selecting from prospective investments. After all, if two securities are otherwise similar in terms of expected returns but one offers a much lower Beta, the investor would do well to select the low Beta security as it would offer better risk-adjusted returns.
Using Beta can help investors determine which securities will produce more volatility than the broader market, such as the ones listed here. The five stocks we’ve looked at offer investors high Beta scores along with very strong prospective returns. For investors that want to take some additional risk in their portfolio, these names and others like them in our list of the 100 best high Beta stocks can help determine what to look for when selecting a high Beta stock to buy.