Alpha and Beta

When you inquire about a stock in Yahoo Finance, Bloomberg or any other financial website, you usually receive a stock summary of key ratios and values. Usually included in the summary are Alpha and beta values for the stock.

Most personal investors don’t understand these two metrics. Both measure stock performance. Both are measures of past performance which may or may not correctly predict the future. So, let’s look more closely at the two measures.

Alpha

Alpha measures a stock’s actual performance against a benchmark such as the S&P 500. It measures the degree of correlation, adjusts it for risk, and then expresses it as a percentage.

So, for example, if a stock were historically outperforming the S&P 500 by 15% but were deemed to be 5% riskier than the index, it would have an alpha of 10%.

Beta

Beta measures a stock’s volatility compared to general market volatility. Beta is expressed as a decimal. A higher beta value indicated greater risk to the investor when compared to the market. A beta of 1.0 means that the stock has the same volatility as the general market.

A stock with a beta higher than 1.0 has greater volatility than the general market.

IES use of Alpha and Beta

Alpha–IES does include this measure as part of our stock selection algorithms.

Beta – IES does not use beta in its stock selection algorithms. The reason is that volatility is often a good thing with the highly rated stocks that IES selects. These stocks are insulated from downside risk. Upside risk is a positive since it may trip a +10% limit earlier. Taking profits earlier is always a good thing.

D.A. Campbell

IslandEquitySystems.com

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