If you are a shareholder in Renren Inc’s (NYSE:RENN), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. Generally, an investor should consider two types of risk that impact the market value of RENN. The first risk to think about is company-specific, which can be diversified away by investing in other companies in order to lower your 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 all stocks are expose 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. 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.
An interpretation of RENN's beta
With a five-year beta of 0.86, Renren appears to be a less volatile company compared to the rest of the market. The stock will exhibit muted movements in both the downside and upside, in response to changing economic conditions, whereas the general market may move by a lot more. RENN’s beta indicates it is a stock that investors may find valuable if they want to reduce the overall market risk exposure of their stock portfolio.
Could RENN's size and industry cause it to be more volatile?
A market capitalisation of USD $546.38M puts RENN in the category of small-cap stocks, which tends to possess higher beta than larger companies. Furthermore, the company operates in the software and services industry, which has been found to have high sensitivity to market-wide shocks. As a result, we should expect a high beta for the small-cap RENN but a low beta for the software and services industry. It seems as though there is an inconsistency in risks portrayed by RENN’s size and industry relative to its actual beta value. There may be a more fundamental driver which can explain this inconsistency, which we will examine below.
Is RENN'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 RENN’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, RENN seems to have a smaller dependency on fixed costs to generate revenue. Thus, we can expect RENN 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 is consistent with is current beta value which also indicates low volatility.
What this means for you:
Are you a shareholder? You could benefit from lower risk during times of economic decline by holding onto RENN. 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 RENN.
Are you a potential investor? Before you buy RENN, you should look at the stock in conjunction with their current portfolio holdings. RENN may be a great cushion during times of economic downturns due to its low beta and low fixed cost. However, in addition to this, I recommend taking into account its fundamentals as well before jumping into the investment.
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 Renren 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 Renren 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.