Question

Given the various industries we examined (i.e. agriculture, tobacco, banks, pharmaceuticals, etc.), which industries do you suspect have the highest betas? Which ones have the lowest betas? Provide an economic explanation for your reason. Hint: Talk about the business operations of each industry and how demand for their products/services is affected during up- and down-markets.

Answer 1

The beta of an industry depends on various economic factors. Some factors are:

• Discretionary products have high beta. e.g Luxury goods; during good times people have money to spend and hence their sales go up while in bad times their sales plummet.
• Industries with high fixed cost have high beta. This is so because when economy is in upswing,the sales and production are high, and hence the fixed cost tends to earn high profits while during a downturn while sales may fall but the fixed costs still have to be borne.
• Utility & Addiction products have low beta, this is because irrespective of the economic cycle these products have to be consumed. Hence agricultural,tobacco & pharmaceutical industries fall in this category.
• An industry with a high borrowing has a high beta because interests are a fixed cost that need to be paid irrespective of the economic cycle. Banks fall in this category because in bad economic cycle they do not have many opportunities to loan the money but they still have to pay interests on the deposits.
• Cyclical companies have higher beta.