If you are looking to invest in American Lorain Corporation’s (AMEX:ALN), or currently own the stock, then you need to understand its beta in order to understand how it can affect the risk of your portfolio. Broadly speaking, there are two types of risk you should consider when investing in stocks such as ALN. The first risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as ALN, because it is rare that an entire industry collapses at once. The other type of risk, which cannot be diversified away, is market risk. Every stock in the market is exposed to this risk, which arises from macroeconomic factors such as economic growth and geo-political tussles just to name a few.
Not every stock is exposed to the same level of market risk. A widely-used metric to measure a stock's market risk is beta, 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.
What does ALN's beta value mean?
American Lorain’s beta of 0.44 indicates that the company is less volatile relative to the diversified market portfolio. This means the stock is more defensive against the ups and downs of a stock market, moving by less than the entire market index in times of change. Based on this beta value, ALN appears to be a stock that an investor with a high-beta portfolio would look for to reduce risk exposure to the market.
How does ALN's size and industry impact its risk?
A market capitalisation of USD $13.78M puts ALN in the category of small-cap stocks, which tends to possess higher beta than larger companies. But, ALN’s industry, food, beverage and tobacco, is considered to be defensive, which means it is less volatile than the market over the economic cycle. As a result, we should expect a high beta for the small-cap ALN but a low beta for the food, beverage and tobacco industry. It seems as though there is an inconsistency in risks from ALN’s size and industry. A potential driver of this variance can be a fundamental factor, which we will take a look at next.
Is ALN'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 ALN’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. With a fixed-assets-to-total-assets ratio of greater than 30%, ALN 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 ALN 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. However, this is the opposite to what ALN’s actual beta value suggests, which is lower stock volatility relative to the market.
What this means for you:
Are you a shareholder? You could benefit from lower risk during times of economic decline by holding onto ALN. 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. Depending on the composition of your portfolio, ALN may be a valuable stock to hold onto in order to cushion the impact of a downturn.
Are you a potential investor? Before you buy ALN, you should look at the stock in conjunction with their current portfolio holdings. ALN may be a great cushion during times of economic downturns due to its low beta. However, its high fixed cost may mean margins are squeezed if demand is low. I recommend taking into account its fundamentals as well before leaping 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 American Lorain 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 American Lorain 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.