If you are looking to invest in Cauldron Energy Limited’s (ASX:CXU), or currently own the stock, then you need to understand its beta in order to understand how it can affect the risk of your portfolio. CXU is exposed to market-wide risk, which arises from investing in the stock market. This risk reflects changes in economic and political factors that affects all stocks, and is measured by its beta. Not all stocks are expose to the same level of market risk, and the market as a whole represents a beta value of one. A stock with a beta greater than one is expected to exhibit higher volatility resulting from market-wide shocks compared to one with a beta below one.
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An interpretation of CXU's beta
Cauldron Energy’s five-year beta of 1.26 means that the company’s value will swing up by more than the market during prosperous times, but also drop down by more in times of downturns. This level of volatility indicates bigger risk for investors who passively invest in the stock market index. Based on this beta value, CXU will help diversify your portfolio, if it currently comprises of low-beta stocks. This will be beneficial for portfolio returns, in particular, when current market sentiment is positive.
Does CXU's size and industry impact the expected beta?
With a market cap of AUD $11.20M, CXU falls within the small-cap spectrum of stocks, which are found to experience higher relative risk compared to larger companies. In addition to size, CXU also operates in the oil, gas and consumable fuels industry, which has commonly demonstrated strong reactions to market-wide shocks. As a result, we should expect higher beta for small-cap stocks in a cyclical industry compared to larger stocks in a defensive industry. This supports our interpretation of CXU’s beta value discussed above. Fundamental factors can also drive the cyclicality of the stock, which we will take a look at next.
Is CXU's cost structure indicative of a high beta?
During times of economic downturn, low demand may cause companies to readjust production of their goods and services. It is more difficult for companies to lower their cost, if the majority of these costs are generated by fixed assets. Therefore, this is a type of risk which is associated with higher beta. I examine CXU’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. Given that fixed assets make up less than a third of the company’s total assets, CXU doesn’t rely heavily upon these expensive, inflexible assets to run its business during downturns. As a result, the company may be less volatile relative to broad market movements, compared to a company of similar size but higher proportion of fixed assets. This outcome contradicts CXU’s current beta value which indicates an above-average volatility.