For Erin Energy Corporation’s (AMEX:ERN) shareholders, and also potential investors in the stock, understanding how the stock’s risk and return characteristics can impact your portfolio is important. The beta measures ERN’s exposure to the wider market risk, which reflects changes in economic and political factors. Not every stock is exposed to the same level of market risk, and the market as a whole represents a beta value of one. A stock with a beta greater than one is considered more sensitive to market-wide shocks compared to a stock that trades below the value of one.
What is ERN’s market risk?
Erin Energy has a beta of 2.3, which means that the percentage change in its stock value will be higher than the entire market in times of booms and busts. A high level of beta means investors face higher risk associated with potential gains and losses driven by market movements. Based on this beta value, ERN will help diversify your portfolio, if it currently comprises of low-beta stocks. This will be beneficial for portfolio returns, in particular, when current market sentiment is positive.
How does ERN’s size and industry impact its risk?
ERN, with its market capitalisation of USD $601.02M, is a small-cap stock, which generally have higher beta than similar companies of larger size. Moreover, ERN’s industry, oil and gas, is considered to be cyclical, which means it is more volatile than the market over the economic cycle. Therefore, investors may expect high beta associated with small companies, as well as those operating in the oil and gas industry, relative to those more well-established firms in a more defensive industry. This is consistent with ERN’s individual beta value we discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.
Is ERN’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 ERN’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. ERN’s fixed assets to total assets ratio of higher than 30% shows that the company uses up a big chunk of its capital on assets that are hard to scale up or down in short notice. Thus, we can expect ERN to be more volatile in the face of market movements, relative to its peers of similar size but with a lower proportion of fixed assets on their books. This is consistent with is current beta value which also indicates high volatility.
What this means for you:
You could benefit from higher returns from ERN during times of economic growth. Its higher fixed cost isn’t a major concern given margins are covered with high consumer demand. Though, in times of a downturn, it may be safe to look at a more defensive stock which can cushion the impact of lower demand. What I have not mentioned in my article here are important company-specific fundamentals such as Erin Energy’s financial health and performance track record. I highly recommend you to complete your research by taking a look at the following:
- 1. Financial Health: Is ERN’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. Past Track Record: Has ERN 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 ERN’s historicals for more clarity.
- 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.
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.