What You Must Know About Sirius Minerals Plc’s (LSE:SXX) Risks
If you are a shareholder in Sirius Minerals Plc’s (LSE:SXX), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. There are two types of risks that affect the market value of a listed company such as SXX. The first risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as SXX, because it is rare that an entire industry collapses at once. 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. The most widely used metric to quantify a stock's market risk is beta, and the market as a whole represents a beta 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.
View our latest analysis for Sirius Minerals
What is SXX’s market risk?
Sirius Minerals has a beta of 1.25, 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. According to this value of beta, SXX may be a stock for investors with a portfolio mainly made up of low-beta stocks. This is because during times of bullish sentiment, you can reap more of the upside with high-beta stocks compared to muted movements of low-beta holdings.
Does SXX's size and industry impact the expected beta?
With a market cap of GBP £1.14B, SXX falls within the small-cap spectrum of stocks, which are found to experience higher relative risk compared to 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 is consistent with SXX’s individual beta value we discussed above. Fundamental factors can also drive the cyclicality of the stock, which we will take a look at next.
Is SXX'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 SXX’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Since SXX’s fixed assets are only 25.37% of its total assets, it doesn’t depend heavily on a high level of these rigid and costly assets to operate its business. Thus, we can expect SXX to be more stable in the face of market movements, relative to its peers of similar size but with a higher portion of fixed assets on their books. However, this is the opposite to what SXX’s actual beta value suggests, which is higher stock volatility relative to the market.
What this means for you:
Are you a shareholder? You could benefit from higher returns during times of economic growth by holding onto SXX. Its low fixed cost also means that, in terms of operating leverage, it is relatively flexible during times of economic downturns. Consider the stock in terms of your other portfolio holdings, and whether it is worth investing more into SXX.
Are you a potential investor? I recommend that you look into SXX's fundamental factors such as its current valuation and financial health. Take into account your portfolio sensitivity to the market before you invest in the stock, as well as where we are in the current economic cycle. SXX may be a great investment during times of economic growth.
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 Sirius Minerals 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 Sirius Minerals 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.
