For Legacy Reserves LP’s (NASDAQ:LGCY) shareholders, and also potential investors in the stock, understanding how the stock’s risk and return characteristics can impact your portfolio is important. Every stock in the market is exposed to market risk, which arises from macroeconomic factors such as economic growth and geo-political tussles just to name a few. This is measured by its beta. 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 expected to exhibit higher volatility resulting from market-wide shocks compared to one with a beta below one.
What is LGCY’s market risk?
With a beta of 2.97, Legacy Reserves is a stock that tends to experience more gains than the market during a growth phase and also a bigger reduction in value compared to the market during a broad downturn. Based on this beta value, LGCY can help magnify your portfolio return, especially if it is predominantly made up of low-beta stocks. If the market is going up, a higher exposure to the upside from a high-beta stock can push up your portfolio return.
Could LGCY’s size and industry cause it to be more volatile?
A market capitalisation of US$274.51M puts LGCY in the category of small-cap stocks, which tends to possess higher beta than larger companies. In addition to size, LGCY also operates in the oil and gas industry, which has commonly demonstrated strong reactions to market-wide shocks. 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 supports our interpretation of LGCY’s beta value discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.
Can LGCY’s asset-composition point to a higher beta?
An asset-heavy company tends to have a higher beta because the risk associated with running fixed assets during a downturn is highly expensive. I test LGCY’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. With a fixed-assets-to-total-assets ratio of greater than 30%, LGCY appears to be a company that invests a large amount of capital in assets that are hard to scale down on short-notice. Thus, we can expect LGCY 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. Similarly, LGCY’s beta value conveys the same message.
What this means for you:
You may reap the gains of LGCY’s returns in times of an economic boom. Though the business does have higher fixed cost than what is considered safe, during times of growth, consumer demand may be high enough to not warrant immediate concerns. However, during a downturn, a more defensive stock can cushion the impact of this risk. In order to fully understand whether LGCY is a good investment for you, we also need to consider important company-specific fundamentals such as Legacy Reserves’s financial health and performance track record. I urge you to complete your research by taking a look at the following:
- Financial Health: Is LGCY’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.
- Past Track Record: Has LGCY 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 LGCY’s historicals for more clarity.
- 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.