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Before You Buy Approach Resources Inc’s (AREX), You Should Consider This

David Owens

If you are looking to invest in Approach Resources Inc’s (NASDAQ:AREX), or currently own the stock, then you need to understand its beta in order to understand how it can affect the risk of your portfolio. AREX is exposed to market-wide risk, which arises from investing in the stock market. This risk reflects changes in economic and political factors that affects all stocks, and is measured by its beta. Different characteristics of a stock expose it to various levels of market risk, and the market as a whole represents a beta value of one. A stock with a beta greater than one is considered more sensitive to market-wide shocks compared to a stock that trades below the value of one.

Check out our latest analysis for Approach Resources

An interpretation of AREX’s beta

Approach Resources’s five-year beta of 2.69 means that the company’s value will swing up by more than the market during prosperous times, but also drop down by more in times of downturns. This level of volatility indicates bigger risk for investors who passively invest in the stock market index. Based on this beta value, AREX will help diversify your portfolio, if it currently comprises of low-beta stocks. This will be beneficial for portfolio returns, in particular, when current market sentiment is positive.

Could AREX’s size and industry cause it to be more volatile?

AREX, with its market capitalisation of USD $207.18M, is a small-cap stock, which generally have higher beta than similar companies of larger size. Furthermore, the company operates in the oil, gas and consumable fuels industry, which has been found to have high sensitivity to market-wide shocks. So, investors should expect a larger beta for smaller companies operating in a cyclical industry in contrast with lower beta for larger firms in a more defensive industry. This supports our interpretation of AREX’s beta value discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.

NasdaqGS:AREX Income Statement Dec 6th 17

Is AREX’s cost structure indicative of a high beta?

During times of economic downturn, low demand may cause companies to readjust production of their goods and services. It is more difficult for companies to lower their cost, if the majority of these costs are generated by fixed assets. Therefore, this is a type of risk which is associated with higher beta. I test AREX’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. AREX’s fixed assets to total assets ratio of higher than 30% shows that the company uses up a big chunk of its capital on assets that are hard to scale up or down in short notice. As a result, this aspect of AREX indicates a higher beta than a similar size company with a lower portion of fixed assets on their balance sheet. This is consistent with is current beta value which also indicates high volatility.

What this means for you:

Are you a shareholder? You could benefit from higher returns from AREX during times of economic growth. Its higher fixed cost isn’t a major concern given margins are covered with high consumer demand. However, in times of a downturn, it may be safe to look at a more defensive stock which can cushion the impact of lower demand. For next steps, take a look at AREX’s outlook to see what analysts are expecting for the stock on our free analysis plaform here.

Are you a potential investor? Before you buy AREX, you should factor how your portfolio currently moves with the wider market, and where we are in the economic cycle. This stock could be an outperformer during times of growth, and it may be worth taking a deeper dive into the fundamentals to crystalize your thoughts on AREX. You can examine these factors in our free fundamental research report for AREX here.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.