If you are a shareholder in East Energy Resources Limited’s (ASX:EER), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of 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 all stocks are expose 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 expected to exhibit higher volatility resulting from market-wide shocks compared to one with a beta below one.
See our latest analysis for East Energy Resources
An interpretation of EER’s beta
East Energy Resources’s beta of 0.94 indicates that the company is less volatile relative to the diversified market portfolio. This means that the change in EER’s value, whether it goes up or down, will be of a smaller degree than the change in value of the entire stock market index. Based on this beta value, EER appears to be a stock that an investor with a high-beta portfolio would look for to reduce risk exposure to the market.
How does EER’s size and industry impact its risk?
A market capitalisation of AU$1.43M puts EER in the category of small-cap stocks, which tends to possess higher beta than larger companies. Furthermore, the company operates in the oil and gas industry, which has been found to have high sensitivity to market-wide shocks. As a result, we should expect a high beta for the small-cap EER but a low beta for the oil and gas industry. This is an interesting conclusion, since both EER’s size and industry indicates the stock should have a higher beta than it currently has. There may be a more fundamental driver which can explain this inconsistency, which we will examine below.
Is EER’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 EER’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. With a fixed-assets-to-total-assets ratio of greater than 30%, EER appears to be a company that invests a large amount of capital in assets that are hard to scale down on short-notice. Thus, we can expect EER 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 EER’s actual beta value suggests, which is lower stock volatility relative to the market.