Beta value and ROE are among the many parameters that investors use to gauge stock performance.
The hunt for finding stocks, which can give multibagger returns, never ends for investors; especially at times when the market witnesses a moderate correction. One such criterion for filtering stocks, which can outperform benchmark indices, is beta value as well as return on equity (ROE).
Frontline indices corrected by about 3 percent from highs and chances of further consolidation cannot be ruled out. But, there will be a lot of action in stock-specific names.
Investors use many parameters for short listing stocks such as earnings per share (EPS), PE, debt to equity ratio, return on capital employed etc. among others.
Beta value is easy to calculate and comes in handy while picking or short listing stocks. In simple terms, it is the measure of individual stock’s volatility or systematic risk with respect to an index.
A beta of 1 indicates that stock price movement will be identical to index movement. A beta of less than 1 means that stocks prices are less volatile when compared to a particular index or market in general while a beta over 1 shows that stock prices are more volatile than the market.
Counting on low beta stocks brings down the volatility in the portfolio which means that if markets head south, chances of stocks falling in your portfolio with the same magnitude is slightly lower.
A high beta stock tends to outperform markets when markets are rallying but huge outperformance is unlikely, suggest experts.
“Analysis of the returns for the past five years suggests that stock returns are hurt when the trailing beta is above 1.1. Beta measures popularity in an indirect way, but more importantly it sets the hurdle rate higher,” Morgan Stanley said in a note.
“A higher hurdle rate reduces the probability of outperformance. Indeed, the risk with the beta is that the trailing number can change abruptly, rendering it less effective,” it said.
Stocks which have low beta or beta less than 1 are companies like KRBL, La Opala, Eveready Industries, Johnson Controls, Astral Poly, Finolex Cables, KPR Mill, Ajanta Pharma, Aarti Industries, Vakrangee and CCL Products.
“Traditionally, the beta has been used as a measure of volatility relative to the market indices and considered a definition of volatility risk. Companies have higher betas and if they have more debt or have a cost structure with higher fixed costs is riskier,” Dyaneshwar Padwal – AVP – Technical Analysis, KIFS Trade Capital told Moneycontrol.
“While choosing high beta stock for the portfolio one should look the debt and fixed cost structure of the company,” he said.
All the above stocks have rallied over 1,000 percent in the last five years. Another important parameter which makes them attractive investment opportunities is a high return on equity (ROE).
“We can use high return on equity for stock selection. As ROE reveals how efficiently a company has used shareholders' money for the future growth. Higher ROE stocks tend to give a higher return in the longer term,” says Padwal.
The ratio summarises the way shareholders’ money is deployed. A higher ROE suggests that management is more efficient in utilising the equity base which in turn offer a better return to shareholders. In general, a ratio between 15-20 percent represents attractive levels of investment quality.
However, ROE might not work well for stocks which have high debt component. A high or even a low ROE needs to be defined with respect to the debt equity relationship.
Top 20 stocks with higher beta value and high ROE: