If you own shares in La Jolla Pharmaceutical Company (NASDAQ:LJPC) then it's worth thinking about how it contributes to the volatility of your portfolio, overall. In finance, Beta is a measure of volatility. Volatility is considered to be a measure of risk in modern finance theory. Investors may think of volatility as falling into two main categories. The first type is company specific volatility. Investors use diversification across uncorrelated stocks to reduce this kind of price volatility across the portfolio. The other type, which cannot be diversified away, is the volatility of the entire market. Every stock in the market is exposed to this volatility, which is linked to the fact that stocks prices are correlated in an efficient market.
Some stocks mimic the volatility of the market quite closely, while others demonstrate muted, exagerrated or uncorrelated price movements. 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. Any stock with a beta of greater than one is considered more volatile than the market, while those with a beta below one are either less volatile or poorly correlated with the market.
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What we can learn from LJPC's beta value
Given that it has a beta of 1.41, we can surmise that the La Jolla Pharmaceutical share price has been fairly sensitive to market volatility (over the last 5 years). Based on this history, investors should be aware that La Jolla Pharmaceutical are likely to rise strongly in times of greed, but sell off in times of fear. 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 La Jolla Pharmaceutical's revenue and earnings in the image below.
How does LJPC's size impact its beta?
La Jolla Pharmaceutical is a noticeably small company, with a market capitalisation of US$158m. Most companies this size are not always actively traded. It takes less money to influence the share price of a very small company. This may explain the excess volatility implied by this beta value.
What this means for you:
Beta only tells us that the La Jolla Pharmaceutical share price is sensitive to broader market movements. This could indicate that it is a high growth company, or is heavily influenced by sentiment because it is speculative. Alternatively, it could have operating leverage in its business model. Ultimately, beta is an interesting metric, but there's plenty more to learn. This article aims to educate investors about beta values, but it's well worth looking at important company-specific fundamentals such as La Jolla Pharmaceutical’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 LJPC’s future growth? Take a look at our free research report of analyst consensus for LJPC’s outlook.
- Past Track Record: Has LJPC 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 LJPC's historicals for more clarity.
- Other Interesting Stocks: It's worth checking to see how LJPC measures up against other companies on valuation. You could start with this free list of prospective options.
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If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Thank you for reading.