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How and When to Calculate Your Own Beta

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How and When to Calculate Your Own Beta

Betas can be a great indicator of how risky a particular equity is to invest in. 

However, many pre-calculated betas are constructed of factors that have nothing to do with your individual portfolio and needs. 

Thus, knowing how to calculate betas for yourself is an invaluable skill as an investor.

First, What is Beta, Exactly?

Simply put, beta is a number that indicates how volatile an equity has been in the past compared to the market as a whole. 

For example, pretend for a moment that the company ZooMed has a beta of 0.5. 

Investors interpret that number to mean that ZooMed only goes up or down half as far as the rest of the market does—say, 5 points for every 10 of the S&P 500’s.

Inversely, pretend that ZooMed has a beta of 1.5. 


Investors take this to mean that it goes up or down half again as far as the rest of the market. 

So, for every 10 points the S&P 500 goes down, ZooMed goes down 15.

Volatility is in the Eye of the Beholder

Some investors are looking for at least a measure of higher beta stock, because while the risk is greater during downturns, so is the reward during upturns. 

Some prefer a lower beta stock that grows and loses more slowly. 

What both kinds of investors would agree on, however, is that they want their beta to be accurate.

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Reasons Why Provided Beta May Not Prove Accurate for You

  • Inappropriate time frames in calculations
  • S&P 500 only standard index considered
  • Accuracy difficult/impossible to assess
  • May not have used appropriate method of calculation

Calculating Your Own Beta Lets You Specify Your Preferred Time Frame

Pre-fab betas were calculated using whatever time frame the statistician chose. 

This may have nothing to do with the length of time you intend to hold on to a stock. 

If the beta calculator took the stock prices for the last three months into consideration, and you are interested in knowing what the stock did for the last three years, you will be out of luck.

You Can Take World Markets into Account

Maybe you are not looking for how a stock has performed compared to the S&P 500 because your stock is overseas and the company you want to invest in is based in Germany. 

Calculating your own beta lets you take into account the performance of the market you care about, not the one that the standard beta calculator assumes you care about.

Calculating Beta Does Not Have to be Scary

Yes, lots of people find math scary. 

Some of those people are even interested in the stock market. 

However, calculating beta is relatively simple if you breathe deeply and make the Internet and Microsoft Excel or Open Office Calc your friends.

All it takes is a little time.

First, Know Your Index and Time Frame

The very first step is always to figure out what market is relevant to your needs. 

It may well be the S&P 500, or it may be an international one. 

The second step is to decide how many months/years of its performance you need to know about to make an educated guess for your investment time frame.

Next, you must gather data and put it in a spreadsheet

Some websites let you do this automatically, and if that’s the case then do it, unless you find something zen about entering large quantities of numbers into excel. 

You will need the closing prices of both your index and the stock whose beta you are calculating, and you will need them for every day of your chosen time frame. 

Put them and a few other data points in Excel as follows:

Column Arrangement in Excel

  • A: The date in question
  • B: The closing price of your index (say, S&P 500)
  • C: The closing price of the stock
  • D: Return percentage for index (described in next paragraph)
  • E: Return percentage for stock

investopedia

To Calculate the Return Percentages on Index or Stock

Subtract the price from yesterday from the price from today, then divide the difference by the price from yesterday. 

This is your percentage change, and if the answer is negative, leave it that way—it just means the stock went down.

Fill out the entire spreadsheet as outlined above.  Make sure that Row 1 is just category headings (i.e., “Date” and so forth)

Now, to Calculate Beta

Step one is very important; it is not to be afraid of the word “Co-variance.”  Beta is the co-variance of columns D and E, divided by the variance of column D.  If you can get past those words and enter the following formula into Excel 2016, you are home free:

Beta=COVARIANCE.S(E2:E99,D2:D99)/VAR.S(number in D2, number in D3…number in D99)

The formula above may vary slightly based on what version of what program you are using. 

By the way, the formula above assumes that you entered 99 data points into Excel.  If you entered a different number of data points, substitute that number for the 99.

Conclusion

Please do not be intimidated and not try to work out your own beta figures. 

With a little practice, you can come up with a number that is far more accurate and appropriate to your needs than anything that someone else will provide for you. 

All it takes is time, patience, and a sense of adventure.

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