If you are a shareholder in Tap Oil Limited’s (ASX:TAP), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. The beta measures TAP’s exposure to the wider market risk, which reflects changes in economic and political factors. Not every stock is exposed to the same level of market risk, and the broad market index represents a beta value 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.
Check out our latest analysis for Tap Oil
What is TAP’s market risk?
Tap Oil’s five-year beta of 1.81 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. According to this value of beta, TAP can help magnify your portfolio return, especially if it is predominantly made up of low-beta stocks. If the market is going up, a higher exposure to the upside from a high-beta stock can push up your portfolio return.
How does TAP’s size and industry impact its risk?
TAP, with its market capitalisation of AUD A$24.71M, is a small-cap stock, which generally have higher beta than similar companies of larger size. In addition to size, TAP also operates in the oil and gas industry, which has commonly demonstrated strong reactions to market-wide shocks. So, investors should expect a larger beta for smaller companies operating in a cyclical industry in contrast with lower beta for larger firms in a more defensive industry. This supports our interpretation of TAP’s beta value discussed above. Fundamental factors can also drive the cyclicality of the stock, which we will take a look at next.
Can TAP’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 test TAP’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. TAP’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 TAP 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. Similarly, TAP’s beta value conveys the same message.