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Should You Be Concerned About Rainbow Rare Earths Limited's (LON:RBW) Historical Volatility?

Simply Wall St

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Anyone researching Rainbow Rare Earths Limited (LON:RBW) might want to consider the historical volatility of the share price. Volatility is considered to be a measure of risk in modern finance theory. Investors may think of volatility as falling into two main categories. The first type is company specific volatility. Investors use diversification across uncorrelated stocks to reduce this kind of price volatility across the portfolio. The second type is the broader market volatility, which you cannot diversify away, since it arises from macroeconomic factors which directly affects all the stocks on the market.

Some stocks see their prices move in concert with the market. Others tend towards stronger, gentler or unrelated price movements. Beta can be a useful tool to understand how much a stock is influenced by market risk (volatility). However, Warren Buffett said 'volatility is far from synonymous with risk' in his 2014 letter to investors. So, while useful, beta is not the only metric to consider. To use beta as an investor, you must first understand that the overall market has a beta of one. Any stock with a beta of greater than one is considered more volatile than the market, while those with a beta below one are either less volatile or poorly correlated with the market.

Check out our latest analysis for Rainbow Rare Earths

What RBW's beta value tells investors

Looking at the last five years, Rainbow Rare Earths has a beta of 1.36. The fact that this is well above 1 indicates that its share price movements have shown sensitivity to overall market volatility. Based on this history, investors should be aware that Rainbow Rare Earths are likely to rise strongly in times of greed, but sell off in times of fear. Many would argue that beta is useful in position sizing, but fundamental metrics such as revenue and earnings are more important overall. You can see Rainbow Rare Earths's revenue and earnings in the image below.

LSE:RBW Income Statement, May 28th 2019

How does RBW's size impact its beta?

Rainbow Rare Earths is a noticeably small company, with a market capitalisation of UK£6.8m. Most companies this size are not always actively traded. It has a relatively high beta, suggesting it is fairly actively traded for a company of its size. Because it takes less capital to move the share price of a small company like this, when a stock this size is actively traded it is quite often more sensitive to market volatility than similar large companies.

What this means for you:

Since Rainbow Rare Earths has a reasonably high beta, it's worth considering why it is so heavily influenced by broader market sentiment. For example, it might be a high growth stock or have a lot of operating leverage in its business model. This article aims to educate investors about beta values, but it's well worth looking at important company-specific fundamentals such as Rainbow Rare Earths’s financial health and performance track record. I highly recommend you dive deeper by considering the following:

  1. Financial Health: Are RBW’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
  2. Valuation: What is RBW worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether RBW is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.