For Nex Metals Explorations Limited’s (ASX:NME) shareholders, and also potential investors in the stock, understanding how the stock’s risk and return characteristics can impact your portfolio is important. Every stock in the market is exposed to market risk, which arises from macroeconomic factors such as economic growth and geo-political tussles just to name a few. This is measured by its beta. Not every stock is exposed to the same level 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.

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An interpretation of NME’s beta

Nex Metals Explorations has a beta of 1.01, which means that the percentage change in its stock value will be higher than the entire market in times of booms and busts. A high level of beta means investors face higher risk associated with potential gains and losses driven by market movements. Based on this beta value, NME 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.

Could NME’s size and industry cause it to be more volatile?

A market capitalisation of AU$3.21M puts NME in the category of small-cap stocks, which tends to possess higher beta than larger companies. Moreover, NME’s industry, metals and mining, is considered to be cyclical, which means it is more volatile than the market over the economic cycle. Therefore, investors may expect high beta associated with small companies, as well as those operating in the metals and mining industry, relative to those more well-established firms in a more defensive industry. This is consistent with NME’s individual beta value we discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.

Can NME’s asset-composition point to a higher 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 NME’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. Considering fixed assets account for less than a third of the company’s overall assets, NME seems to have a smaller dependency on fixed costs to generate revenue. Thus, we can expect NME to be more stable in the face of market movements, relative to its peers of similar size but with a higher portion of fixed assets on their books. However, this is the opposite to what NME’s actual beta value suggests, which is higher stock volatility relative to the market.