If you own shares in Arena Pharmaceuticals Inc (NASDAQ:ARNA) then it’s worth thinking about how it contributes to the volatility of your portfolio, overall. In finance, Beta is a measure of volatility. 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 other type, which cannot be diversified away, is the volatility of the entire market. Every stock in the market is exposed to this volatility, which is linked to the fact that stocks prices are correlated in an efficient market.
Some stocks mimic the volatility of the market quite closely, while others demonstrate muted, exagerrated or uncorrelated price movements. Some investors use beta as a measure of how much a certain stock is impacted by market risk (volatility). While we should keep in mind that Warren Buffett has cautioned that ‘Volatility is far from synonymous with risk’, beta is still a useful factor to consider. To make good use of it you must first know that the beta of the overall market is 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.
What does ARNA’s beta value mean to investors?
Looking at the last five years, Arena Pharmaceuticals has a beta of 1.56. The fact that this is well above 1 indicates that its share price movements have shown sensitivity to overall market volatility. If this beta value holds true in the future, Arena Pharmaceuticals shares are likely to rise more than the market when the market is going up, but fall faster when the market is going down. 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 Arena Pharmaceuticals’s revenue and earnings in the image below.
Does ARNA’s size influence the expected beta?
With a market capitalisation of US$2.0b, Arena Pharmaceuticals is a small cap stock. However, it is big enough to catch the attention of professional investors. It is quite common to see a small-cap stock with a beta greater than one. In part, that’s because relatively few investors can influence the price of a smaller company, compared to a large company.
What this means for you:
Beta only tells us that the Arena Pharmaceuticals share price is sensitive to broader market movements. This could indicate that it is a high growth company, or is heavily influenced by sentiment because it is speculative. Alternatively, it could have operating leverage in its business model. Ultimately, beta is an interesting metric, but there’s plenty more to learn. In order to fully understand whether ARNA is a good investment for you, we also need to consider important company-specific fundamentals such as Arena Pharmaceuticals’s financial health and performance track record. I highly recommend you dive deeper by considering the following:
- Future Outlook: What are well-informed industry analysts predicting for ARNA’s future growth? Take a look at our free research report of analyst consensus for ARNA’s outlook.
- Past Track Record: Has ARNA been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of ARNA’s historicals for more clarity.
- Other Interesting Stocks: It’s worth checking to see how ARNA measures up against other companies on valuation. You could start with this free list of prospective options.
To help readers see past 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. For errors that warrant correction please contact the editor at email@example.com.