What is Beta of a stock, When considering a stock’s risk?

Beta is the measure of systematic risk or the degree to which the return of a stock vary with respect to the return of over all market. By definition the market has a beta of 1 and individual stocks are ranked according to deviation they show with respect to market beta i.e 1. If the beta of a stock is equal to 1 then it means that your stock will have a strong positive correlation(i.e coefficient of correlation is equal to 1) with the beta of the market. If stock have a beta greater than 1, say beta is equal to 2, then it means that the stock will give double return or double loss with respect to market movements. So higher the beta of the stock higher the return or risk associated with the stock, if market is bullish then you will get a higher return and if market is bearish you incur a loss. If beta of stock is less than 1, say 0.5 then it means that the stock will gave half the returns or half the losses with respect to market movements

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Systematic risks are those risks that affect the overall market. These risks are due to the factors that affect the entire market such as change in investment policies, change in foreign investment policies, change in taxation clauses, shift in socio-economic parameters, global security threats etc. This type of risk is beyond the control of investors and cannot be mitigated to a large extent. “Black Monday” on October 19th 1987 was a systematic risk event, in that all stocks fell in value in a single day.

Unsystematic risks are specific to a company or industry. Unsystematic risk is due the factors specific to a company like product category, research & development, marketing strategy etc. This type of risk is avoidable by diversifying your portfolio and taking a calculated risk. So if in your portfolio you have 100% stock of one company and your chosen company goes bankrupt than you loose 100% of your money, on the contrary if you have diversified portfolio with stocks of different companies from different sectors then you can reduce your risk and may loose a very small amount.

How to calculate Beta of a stock

Beta is calculated with regression analysis. The formula for calculating the beta is the co-variance of the return of stock and market divided by the variance of the return of the market.