Should You Be Concerned About MEG Energy Corp’s (TSX:MEG) Risks?
For MEG Energy Corp’s (TSX:MEG) shareholders, and also potential investors in the stock, understanding how the stock’s risk and return characteristics can impact your portfolio is important. Every stock in the market is exposed to market risk, which arises from macroeconomic factors such as economic growth and geo-political tussles just to name a few. This 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 of one. A stock with a beta greater than one is expected to exhibit higher volatility resulting from market-wide shocks compared to one with a beta below one.
View our latest analysis for MEG Energy
An interpretation of MEG's beta
MEG Energy’s five-year beta of 3.59 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, MEG 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.
How does MEG's size and industry impact its risk?
MEG, with its market capitalisation of CAD $1.60B, is a small-cap stock, which generally have higher beta than similar companies of larger size. Moreover, MEG’s industry, oil, gas and consumable fuels, is considered to be cyclical, which means it is more volatile than the market over the economic cycle. Therefore, investors may expect high beta associated with small companies, as well as those operating in the oil, gas and consumable fuels industry, relative to those more well-established firms in a more defensive industry. This supports our interpretation of MEG’s beta value discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.
Is MEG'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 MEG’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Given a fixed to total assets ratio of over 30%, MEG seems to be a company which invests a big chunk of its capital on assets that cannot be scaled down on short-notice. As a result, this aspect of MEG indicates a higher beta than a similar size company with a lower portion of fixed assets on their balance sheet. Similarly, MEG’s beta value conveys the same message.
What this means for you:
Are you a shareholder? You may reap the gains of MEG's returns in times of an economic boom. Though the business does have higher fixed cost than what is considered safe, during times of growth, consumer demand may be high enough to not warrant immediate concerns. However, during a downturn, a more defensive stock can cushion the impact of this risk.
Are you a potential investor? Before you buy MEG, 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 MEG.
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 MEG 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 MEG 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.
