If you are a shareholder in First Growth Funds Limited’s (ASX:FGF), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. FGF 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. Different characteristics of a stock expose it to various levels of market risk, and the market as a whole represents a beta of one. A stock with a beta greater than one is considered more sensitive to market-wide shocks compared to a stock that trades below the value of one.

View our latest analysis for First Growth Funds

What does FGF’s beta value mean?

With a beta of 5.54, First Growth Funds is a stock that tends to experience more gains than the market during a growth phase and also a bigger reduction in value compared to the market during a broad downturn. According to this value of beta, FGF 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.

How does FGF’s size and industry impact its risk?

A market capitalisation of AU$17.95M puts FGF in the category of small-cap stocks, which tends to possess higher beta than larger companies. Furthermore, the company operates in the capital markets industry, which has been found to have high sensitivity 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 FGF’s beta value discussed above.

How FGF’s assets could affect its beta

An asset-heavy company tends to have a higher beta because the risk associated with running fixed assets during a downturn is highly expensive. I test FGF’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Considering fixed assets is virtually non-existent in FGF’s operations, it has low dependency on fixed costs to generate revenue. 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. However, this is the opposite to what FGF’s actual beta value suggests, which is higher stock volatility relative to the market.

What this means for you:

You could reap the gains of FGF’s returns in times of an economic boom. However, during a downturn, a more defensive stock can cushion the impact of this risk. Depending on the composition of your portfolio, high-beta stocks such as FGF is valuable to pump up your returns, in particular, during times of economic growth. What I have not mentioned in my article here are important company-specific fundamentals such as First Growth Funds’s financial health and performance track record. I urge you to complete your research by taking a look at the following: