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For Po Valley Energy Limited’s (ASX:PVE) 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 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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An interpretation of PVE’s beta
Po Valley Energy has a beta of 3.84, 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. According to this value of beta, PVE 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.
Does PVE’s size and industry impact the expected beta?
A market capitalisation of AU$21.95M puts PVE in the category of small-cap stocks, which tends to possess higher beta than larger companies. Moreover, PVE’s industry, oil and gas, is considered to be cyclical, which means it is more volatile than the market over the economic cycle. As a result, we should expect higher beta for small-cap stocks in a cyclical industry compared to larger stocks in a defensive industry. This is consistent with PVE’s individual beta value we discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.
Is PVE’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 PVE’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. With a fixed-assets-to-total-assets ratio of greater than 30%, PVE 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 PVE 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, PVE’s beta value conveys the same message.