If you are a shareholder in Santos Limited’s (ASX:STO), 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 STO’s exposure to the wider market risk, which reflects changes in economic and political factors. Not all stocks are expose to the same level of market risk, and the market as a whole represents a beta 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 STO's beta
Santos’s five-year beta of 1.93 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, STO 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 STO's size and industry impact its risk?
STO has a market capitalization of AUD $8.35B, putting it in the category of established companies, which are found to experience less relative risk compared to small-sized companies. However, STO operates in the oil, gas and consumable fuels industry, which has commonly demonstrated strong reactions to market-wide shocks. Therefore, investors can expect a low beta associated with the size of STO, but a higher beta given the nature of the industry it operates in. It seems as though there is an inconsistency in risks from STO’s size and industry. There may be a more fundamental driver which can explain this inconsistency, which we will examine below.
How STO's assets could affect its 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 STO’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. Given a fixed to total assets ratio of over 30%, STO seems to be a company which invests a big chunk of its capital on assets that cannot be scaled down on short-notice. As a result, this aspect of STO indicates a higher beta than a similar size company with a lower portion of fixed assets on their balance sheet. This is consistent with is current beta value which also indicates high volatility.