If you are a shareholder in FutureFuel Corp’s (NYSE:FF), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. Broadly speaking, there are two types of risk you should consider when investing in stocks such as FF. The first type is company-specific risk, which can be diversified away by investing in other companies to reduce exposure to one particular stock. The second risk is market-wide, which arises from investing in the stock market. This risk reflects changes in economic and political factors that affects all stocks.
Not every stock is exposed to the same level of market risk. A widely-used metric to measure a stock's market risk is beta, and the broad market index 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 FF’s market risk?
FutureFuel’s five-year beta of 1.76 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, FF 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 FF's size and industry cause it to be more volatile?
A market capitalisation of USD $657.56M puts FF in the category of small-cap stocks, which tends to possess higher beta than larger companies. Furthermore, the company operates in the materials industry, which has been found to have high sensitivity to market-wide shocks. So, investors should expect a larger beta for smaller companies operating in a cyclical industry in contrast with lower beta for larger firms in a more defensive industry. This supports our interpretation of FF’s beta value discussed above. Fundamental factors can also drive the cyclicality of the stock, which we will take a look at next.
Can FF'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 FF’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%, FF 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 FF 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:
Are you a shareholder? You could benefit from higher returns from FF during times of economic growth. Its higher fixed cost isn’t a major concern given margins are covered with high consumer demand. However, in times of a downturn, it may be safe to look at a more defensive stock which can cushion the impact of lower demand.
Are you a potential investor? Before you buy FF, you should factor how your portfolio currently moves with the wider market, and where we are in the economic cycle. This stock could be an outperformer during times of growth, and it may be worth taking a deeper dive into the fundamentals to crystalize your thoughts on FF.
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 FutureFuel 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 FutureFuel 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.