For RMG Limited’s (ASX:RMG) shareholders, and also potential investors in the stock, understanding how the stock’s risk and return characteristics can impact your portfolio is important. RMG is exposed to market-wide risk, which arises from investing in the stock market. This risk reflects changes in economic and political factors that affects all stocks, and is measured by its beta. Not every stock is exposed to the same level of market risk, and the broad market index 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.
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An interpretation of RMG’s beta
With a beta of 1.06, RMG is a stock that tends to experience more gains than the market during a growth phase and also a bigger reduction in value compared to the market during a broad downturn. According to this value of beta, RMG may be a stock for investors with a portfolio mainly made up of low-beta stocks. This is because during times of bullish sentiment, you can reap more of the upside with high-beta stocks compared to muted movements of low-beta holdings.
How does RMG’s size and industry impact its risk?
With a market cap of AUD A$13.03M, RMG falls within the small-cap spectrum of stocks, which are found to experience higher relative risk compared to larger companies. Moreover, RMG’s industry, metals and mining, 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 metals and mining industry, relative to those more well-established firms in a more defensive industry. This supports our interpretation of RMG’s beta value discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.
Is RMG’s cost structure indicative of a high beta?
An asset-heavy company tends to have a higher beta because the risk associated with running fixed assets during a downturn is highly expensive. I test RMG’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Given a fixed to total assets ratio of over 30%, RMG seems to be a company which invests a big chunk of its capital on assets that cannot be scaled down on short-notice. Thus, we can expect RMG 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, RMG’s beta value conveys the same message.