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If you own shares in Ellington Residential Mortgage REIT (NYSE:EARN) then it's worth thinking about how it contributes to the volatility of your portfolio, overall. In finance, Beta is a measure of volatility. Modern finance theory considers volatility to be a measure of risk, and there are two main types of price volatility. 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 sort is caused by the natural volatility of markets, overall. For example, certain macroeconomic events will impact (virtually) all stocks on the market.
Some stocks are more sensitive to general market forces than others. 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. A stock with a beta greater than one is more sensitive to broader market movements than a stock with a beta of less than one.
What does EARN's beta value mean to investors?
Looking at the last five years, Ellington Residential Mortgage REIT has a beta of 0.80. The fact that this is well below 1 indicates that its share price movements haven't historically been very sensitive to overall market volatility. This means that -- if history is a guide -- buying the stock would reduce the impact of overall market volatility in many portfolios (depending on the beta of the portfolio, of course). 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 Ellington Residential Mortgage REIT's revenue and earnings in the image below.
Could EARN's size cause it to be more volatile?
Ellington Residential Mortgage REIT is a noticeably small company, with a market capitalisation of US$137m. Most companies this size are not always actively traded. Very small companies often have a low beta value because their share prices are not well correlated with market volatility. This could be because the price is reacting to company specific events. Alternatively, the shares may not be actively traded.
What this means for you:
The Ellington Residential Mortgage REIT doesn't usually show much sensitivity to the broader market. This could be for a variety of reasons. Typically, smaller companies have a low beta if their share price tends to move a lot due to company specific developments. Alternatively, an strong dividend payer might move less than the market because investors are valuing it for its income stream. In order to fully understand whether EARN is a good investment for you, we also need to consider important company-specific fundamentals such as Ellington Residential Mortgage REIT’s financial health and performance track record. I urge you to continue your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for EARN’s future growth? Take a look at our free research report of analyst consensus for EARN’s outlook.
Past Track Record: Has EARN 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 EARN's historicals for more clarity.
Other Interesting Stocks: It's worth checking to see how EARN measures up against other companies on valuation. You could start with this free list of prospective options.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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