Before You Buy Toro Energy Limited’s (ASX:TOE), You Should Consider This
If you are a shareholder in Toro Energy Limited’s (ASX:TOE), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. TOE 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. Not every stock is exposed to the same level of market risk, and the broad market index 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 Toro Energy
What is TOE’s market risk?
Toro Energy’s five-year beta of 1.27 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, TOE 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 TOE's size and industry cause it to be more volatile?
A market capitalisation of AUD $58.23M puts TOE in the category of small-cap stocks, which tends to possess higher beta than larger companies. In addition to size, TOE also operates in the oil, gas and consumable fuels industry, which has commonly demonstrated strong reactions 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 TOE’s beta value discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.
Can TOE's asset-composition point to a higher beta?
An asset-heavy company tends to have a higher beta because the risk associated with running fixed assets during a downturn is highly expensive. I examine TOE’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. With a fixed-assets-to-total-assets ratio of greater than 30%, TOE appears to be a company that invests a large amount of capital in assets that are hard to scale down on short-notice. Thus, we can expect TOE to be more volatile in the face of market movements, relative to its peers of similar size but with a lower proportion of fixed assets on their books. Similarly, TOE’s beta value conveys the same message.
What this means for you:
Are you a shareholder? You could benefit from higher returns from TOE 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.
Are you a potential investor? Before you buy TOE, 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 TOE.
Beta is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Toro Energy for a more in-depth analysis of the stock to help you make a well-informed investment decision. But if you are not interested in Toro Energy anymore, you can use our free platform to see my list of over 50 other stocks with a high growth potential.
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.
