How to Interpret the Beta of a Stock

This video shows how to interpret the beta of a stock. Examples of beta from actual firms are presented and interpreted. Firms with a beta greater than one have higher systematic risk than average, whereas firms with a beta less than one have less systematic risk than average. To understand why firms have different levels of systematic risk, consider the following: a grocery store will likely have a beta less than one because in the event of a market downturn people are likely to continue buying food. A company that sells high-end jewelry, however, is likely to have a beta higher than one; when times are good people are eager to purchase luxury goods, but when times are bad people drastically reduce such purchases. If a firm were to have a beta of zero, this would mean that the firm bears no systematic risk; the firm's return is not affected by the return of the market portfolio at all. It is possible for a firm to have a negative beta, although it is rare. This would occur if the firm does very well when the market portfolio does poorly; investing in such a firm would effectively provide insurance against a market downturn. This explains why an investor might choose to invest in such a firm, even though the firm has a return that is less than the risk-free rate according to the Capital Asset Pricing Model.

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