If you are a shareholder in Strike Resources Limited’s (ASX:SRK), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. There are two types of risks that affect the market value of a listed company such as SRK. The first risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as SRK, because it is rare that an entire industry collapses at once. The second type is market risk, one that you cannot diversify away, since it arises from macroeconomic factors which directly affects all the stocks in the market.
Different characteristics of a stock expose it to various levels of market risk. A popular measure of market risk for a stock is its beta, and the market as a whole 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.
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What does SRK's beta value mean?
Strike Resources's beta of 0.38 indicates that the stock value will be less variable compared to the whole stock market.This means the stock is more defensive against the ups and downs of a stock market, moving by less than the entire market index in times of change.SRK's beta implies it may be a stock that investors with high-beta portfolios might find relevant if they wanted to reduce their exposure to market risk, especially during times of downturns.
Does SRK's size and industry impact the expected beta?
SRK, with its market capitalisation of AUD $5.81M, is a small-cap stock, which generally have higher beta than similar companies of larger size. In addition to size, SRK also operates in the materials industry, which has commonly demonstrated strong reactions to market-wide shocks. As a result, we should expect a high beta for the small-cap SRK but a low beta for the materials industry. It seems as though there is an inconsistency in risks portrayed by SRK’s size and industry relative to its actual beta value. There may be a more fundamental driver which can explain this inconsistency, which we will examine below.
Is SRK'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 test SRK’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint.Since SRK’s fixed assets are only 6.44% of its total assets, it doesn’t depend heavily on a high level of these rigid and costly assets to operate its business.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. This is consistent with is current beta value which also indicates low volatility.