If you are a shareholder in Entrée Resources Ltd’s (TSX:ETG), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. The beta measures ETG’s exposure to the wider market risk, which reflects changes in economic and political factors. Different characteristics of a stock expose it to various levels of market risk, and the market as a whole represents a beta value of one. Any stock with a beta of greater than one is considered more volatile than the market, and those with a beta less than one is generally less volatile.
What is ETG’s market risk?
Entrée Resources’s five-year beta of 2.4 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. According to this value of beta, ETG may be a stock for investors with a portfolio mainly made up of low-beta stocks. This is because during times of bullish sentiment, you can reap more of the upside with high-beta stocks compared to muted movements of low-beta holdings.
Does ETG's size and industry impact the expected beta?
ETG, with its market capitalisation of USD $88.32M, is a small-cap stock, which generally have higher beta than similar companies of larger size. Moreover, ETG’s industry, metals and mining, is considered to be cyclical, which means it is more volatile than the market over the economic cycle. As a result, we should expect higher beta for small-cap stocks in a cyclical industry compared to larger stocks in a defensive industry. This is consistent with ETG’s individual beta value we discussed above. Fundamental factors can also drive the cyclicality of the stock, which we will take a look at next.
Is ETG'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 ETG’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Considering fixed assets account for less than a third of the company's overall assets, ETG seems to have a smaller dependency on fixed costs to generate revenue. As a result, the company may be less volatile relative to broad market movements, compared to a company of similar size but higher proportion of fixed assets. This outcome contradicts ETG’s current beta value which indicates an above-average volatility.
What this means for you:
Are you a shareholder? You could benefit from higher returns during times of economic growth by holding onto ETG. Its low fixed cost also means that, in terms of operating leverage, it is relatively flexible during times of economic downturns. Consider the stock in terms of your other portfolio holdings, and whether it is worth investing more into ETG.
Are you a potential investor? Before you buy ETG, you should take into account how their portfolio currently moves with the market, in addition to the current economic environment. ETG may be a valuable addition to portfolios during times of economic growth, and it may be work looking further into fundamental factors such as current valuation and financial health.
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 Entrée Resources 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 Entrée Resources 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.