What You Must Know About Armour Energy Limited’s (ASX:AJQ) Risks
For Armour Energy Limited’s (ASX:AJQ) 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. Different characteristics of a stock expose it to various levels of market risk, 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.
See our latest analysis for Armour Energy
What is AJQ’s market risk?
With a beta of 1.6, Armour Energy 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. According to this value of beta, AJQ 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.
Could AJQ’s size and industry cause it to be more volatile?
A market capitalisation of AU$32.01M puts AJQ in the category of small-cap stocks, which tends to possess higher beta than larger companies. Moreover, AJQ’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 AJQ’s individual beta value we discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.
Is AJQ’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 examine AJQ’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. With a fixed-assets-to-total-assets ratio of greater than 30%, AJQ 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 AJQ 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 may reap the gains of AJQ’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 AJQ is a good investment for you, we also need to consider important company-specific fundamentals such as Armour 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 AJQ’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 AJQ 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 AJQ’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.
