Question

What are some reasons for changes in beta and should one should be more concerned with a negative versus positive factor.

Answer 1

Beta is a measure of a stock’s systematic, or market, risk, and offers investors a good indication of an issue’s volatility relative to the overall stock market. The market beta is set at 1.00, and a stock’s beta is calculated by Value Line, based on past stock-price volatility. If an equity has a beta of 1.00, it will probably move in lock step with the broader market. For example, if the market rises (falls) by 10%, an issue with a beta of 1.00 will probably increase (decrease) by about the same amount. A beta above 1.00 indicates that a stock’s volatility is greater than the market. For instance, an issue with a beta of 1.30 has a level of volatility 30% greater than the market average. Hence, given a 10% increase (decrease) in the stock market, our hypothetical issue will probably climb (fall) about 13%. The reverse is also true. A stock with a beta of .70 has lower volatility than the overall market, and a broad increase (decrease) of 10% would likely result in a 7% gain (loss) for our low-beta issue.

Betas tend to vary across companies and industries. Stocks of large companies with numerous operating segments, such as Hewlett-Packard (HPQ), tend to have betas close to 1.00, as demand for their products tends to increase or decrease in line with aggregate economic expansion or contraction. Defensive stocks that generate relatively consistent earnings regardless of the economic climate typically have lower betas. For example,Abbott Laboratories (ABT), a pharmaceutical and healthcare company, has a beta of .60, 40% lower than the market. Demand for the company’s products is inelastic, making it hard for people to stop buying them or find substitutes. All of this leads to a relatively steady earnings stream and the stock’s lower level of volatility. Conversely, companies in cyclical industries typically have higher betas. AMR Corporation (AMR), which owns American Airlines, has a beta of 1.65, 65% higher than the market average. When the economy slows, demand for travel and other such luxuries tends to decline dramatically, and vice versa, resulting in more volatile earnings and share-price movements.

Conservative investors will likely favor stocks with low betas in order to limit volatility. However, investors need to remember that beta is a double-edged sword. Issues with low betas won’t fall as much as the broader market on the way down, but when the market rallies, they will likely be relative underperformers.

Thus, volatile securities can and often do have low market betas. ... Betas can and do change over time, as companies change their business. The regression assumes that betas are fixed over the estimation period. This is why analysis use a limited time period, say, five years, to obtain beta.

Beta is a popular and an useful metric. It is a neat number and in one number we get an idea of the risk the asset is going to add to a well diversified portfolio. The important points to consider while estimating beta of any assets are:
1. An appropriate proxy for the “market”
2. Return periodicity i.e. do we consider daily return or weekly return or monthly return etc
3. Period of analysis – over one month, one year, five years ...
I go for weekly returns over a two year period. This gives a data set of about 100 which is just about large enough for a meaningful statistical analysis. Daily returns, I feel, have far too much of “noise”. I also feel that in these fast changing times analysis over a long period (say five years or longer) is not very appropriate as the risk profile of the firm may suffered significant changes over the period. Many others feel that one should take monthly returns over a five year period for a better estimation. I will say it is good that we have diversity.

If risk profile of a firm changes over time, so should its beta. I have estimated rolling betas for a few firms in the past and sure enough betas have varied over time but not really in any dramatic fashion.

SAIL’s beta has risen significantly from 0.9 to 1.4+. But compare with a case reported by Bill Rempel here :
Simon Property Group (SPG), a REIT, currently shows a Beta of 1.75 to the S&P 500 (it is a member). In a spreadsheet I confirmed that the slope of the regression line for the prior 36 monthly adjusted (incl. dividends) price changes of SPG to SPY (an ETF tracking the S&P 500 index) is 1.75, so that is the basis (monthly changes over the last 36 months) of their Beta calculation.

I then calculated a rolling 36-month Beta for SPG from Jan 1997 (3 years after it started trading) through today. 45 of the 164 observations showed negative Beta. Most of these instances occurred during the Tech Bubble (in which REITs didn't participate) and during the following Bear Market (in which REITs didn't participate due to the then-starting Real Estate Bubble).

It was not until Oct 2005 that SPG's Beta exceeded 0.50. An analyst naive enough to see Beta as a property of stocks, or foolish enough to think that correlations hold relatively constant, would have been damaged if they chose to try and make money on those assumptions with SPG, as by Apr 2006 SPG's Beta to the S&P 500 began to consistently exceed 1.00, generally exceeding 1.40 since that time.

Bill concludes: Be reminded that "beta" is merely an observation about a stock's return over some sample period, and not a permanent, immutable characteristic of that stock. "Betas" change over time, sometimes very rapidly, over time.

A negative beta correlation means an investment moves in the opposite direction from the stock market. When the market rises, a negative-beta investment generally falls. When the market falls, the negative-beta investment will tend to rise. ... Negative beta is an unusual concept, as it pertains to the stock market.

Risk Factors and Beta
A negative beta coefficient does not necessarily mean absence of risk. Instead, negative beta means your investment offers a hedge against serious market downturns. If the market continues rising, however, a negative-beta investment is losing money through opportunity risk – the loss of the chance to make higher returns – and inflation risk, in which a low rate of return does not keep pace with inflation. Because the stock market has historically produced a positive return in most years, the mere act of investing in negative-or low-beta stocks increases these risks over time.

Negative beta. A beta less than 0, which would indicate an inverse relation to the market, is possible but highly unlikely. However, some investors believe that gold and gold stocks should have negative betas because they tended to do better when the stock market declines.