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If you are looking to invest in Metgasco Limited’s (ASX:MEL), or currently own the stock, then you need to understand its beta in order to understand how it can affect the risk of your portfolio. MEL 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. Different characteristics of a stock expose it to various levels 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.
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An interpretation of MEL’s beta
Metgasco’s five-year beta of 2.37 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, MEL 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.
Could MEL’s size and industry cause it to be more volatile?
With a market cap of AU$24.31M, MEL falls within the small-cap spectrum of stocks, which are found to experience higher relative risk compared to larger companies. In addition to size, MEL also operates in the oil and gas industry, which has commonly demonstrated strong reactions to market-wide shocks. 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 MEL’s individual beta value we discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.
Is MEL’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 MEL’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Given that fixed assets make up an insignificant portion of total assets, MEL doesn’t rely heavily upon these expensive, inflexible assets to run its business during downturns. Thus, we can expect MEL to be more stable in the face of market movements, relative to its peers of similar size but with a higher portion of fixed assets on their books. This outcome contradicts MEL’s current beta value which indicates an above-average volatility.