Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
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. First, we have company specific volatility, which is the price gyrations of an individual stock. Holding at least 8 stocks can reduce this kind of risk across a 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 are more sensitive to general market forces than others. Beta is a widely used metric to measure a stock's exposure to market risk (volatility). Before we go on, it's worth noting that Warren Buffett pointed out in his 2014 letter to shareholders that 'volatility is far from synonymous with risk.' Having said that, beta can still be rather useful. The first thing to understand about beta is that the beta of the overall market is one. A stock with a beta below one is either less volatile than the market, or more volatile but not corellated with the overall market. In comparison a stock with a beta of over one tends to be move in a similar direction to the market in the long term, but with greater changes in price.
What we can learn from ARNA's beta value
Zooming in on Arena Pharmaceuticals, we see it has a five year beta of 1.75. This is above 1, so historically its share price has been influenced by the broader volatility of the stock market. If the past is any guide, we would expect that Arena Pharmaceuticals shares will rise quicker than the markets in times of optimism, but fall faster in times of pessimism. 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.
Could ARNA's size cause it to be more volatile?
Arena Pharmaceuticals is a fairly large company. It has a market capitalisation of US$2.8b, which means it is probably on the radar of most investors. It has a relatively high beta, suggesting it may be somehow leveraged to macroeconomic conditions. For example, it might be a high growth stock with lots of investors trading the shares. It's notable when large companies to have high beta values, because it usually takes substantial capital flows to move their share prices.
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.
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 email@example.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.