For TerraCom Limited’s (ASX:TER) 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. Different characteristics of a stock expose it to various levels of market risk, and the market as a whole represents a beta value of one. Any stock with a beta of greater than one is considered more volatile than the market, and those with a beta less than one is generally less volatile.

See our latest analysis for TerraCom

What is TER’s market risk?

TerraCom’s beta of 0.72 indicates that the stock value will be less variable compared to the whole stock market. The stock will exhibit muted movements in both the downside and upside, in response to changing economic conditions, whereas the general market may move by a lot more. TER’s beta indicates it is a stock that investors may find valuable if they want to reduce the overall market risk exposure of their stock portfolio.

Does TER’s size and industry impact the expected beta?

With a market cap of AUD A$64.95M, TER falls within the small-cap spectrum of stocks, which are found to experience higher relative risk compared to larger companies. Moreover, TER’s industry, oil and gas, 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 oil and gas industry, relative to those more well-established firms in a more defensive industry. It seems as though there is an inconsistency in risks portrayed by TER’s size and industry relative to its actual beta value. A potential driver of this variance can be a fundamental factor, which we will take a look at next.

Is TER’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 TER’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. TER’s fixed assets to total assets ratio of higher than 30% shows that the company uses up a big chunk of its capital on assets that are hard to scale up or down in short notice. Thus, we can expect TER to be more volatile in the face of market movements, relative to its peers of similar size but with a lower proportion of fixed assets on their books. However, this is the opposite to what TER’s actual beta value suggests, which is lower stock volatility relative to the market.