If you are a shareholder in Arena Pharmaceuticals Inc’s (NASDAQ:ARNA), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. The beta measures ARNA’s exposure to the wider market risk, which reflects changes in economic and political factors. Different characteristics of a stock expose it to various levels of market risk, and the broad market index represents a beta value of one. Any stock with a beta of greater than one is considered more volatile than the market, and those with a beta less than one is generally less volatile.
What does ARNA's beta value mean?
With a beta of 1.37, Arena Pharmaceuticals 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, ARNA 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 ARNA's size and industry impact the expected beta?
ARNA, with its market capitalisation of USD $1.00B, is a small-cap stock, which generally have higher beta than similar companies of larger size. Conversely, the company operates in the biotechnology industry, which has been found to have low sensitivity to market-wide shocks. Therefore, investors can expect a high beta associated with the size of ARNA, but a lower beta given the nature of the industry it operates in. It seems as though there is an inconsistency in risks from ARNA’s size and industry. A potential driver of this variance can be a fundamental factor, which we will take a look at next.
Is ARNA's cost structure indicative of a high 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 ARNA’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Considering fixed assets account for less than a third of the company's overall assets, ARNA seems to have a smaller dependency on fixed costs to generate revenue. Thus, we can expect ARNA 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. This outcome contradicts ARNA’s current beta value which indicates an above-average volatility.
What this means for you:
Are you a shareholder? You could benefit from higher returns during times of economic growth by holding onto ARNA. 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 ARNA.
Are you a potential investor? Before you buy ARNA, you should take into account how their portfolio currently moves with the market, in addition to the current economic environment. ARNA may be a valuable addition to portfolios during times of economic growth, and it may be work looking further into fundamental factors such as current valuation and financial health.
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 Arena Pharmaceuticals 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 Arena Pharmaceuticals 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.