How Should You Think About Peat Resources Limited’s (TSXV:PET) Risks?
If you are a shareholder in Peat Resources Limited’s (TSXV:PET), 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 PET. The first type is company-specific risk, which can be diversified away by investing in other companies to reduce 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.
Different characteristics of a stock expose it to various levels 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.
Check out our latest analysis for Peat Resources
What is PET’s market risk?
With a beta of 2.25, Peat Resources 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, PET can help magnify your portfolio return, especially if it is predominantly made up of low-beta stocks. If the market is going up, a higher exposure to the upside from a high-beta stock can push up your portfolio return.
Could PET's size and industry cause it to be more volatile?
With a market cap of CAD $990.97K, PET 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 energy industry, which has been found to have high sensitivity to market-wide shocks. As a result, we should expect higher beta for small-cap stocks in a cyclical industry compared to larger stocks in a defensive industry. This is consistent with PET’s individual beta value we discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.
How PET's assets could affect its 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 PET’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Given a fixed to total assets ratio of over 30%, PET seems to be a company which invests a big chunk of its capital on assets that cannot be scaled down on short-notice. Thus, we can expect PET 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. Similarly, PET’s beta value conveys the same message.
What this means for you:
Are you a shareholder? You may reap the gains of PET'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.
Are you a potential investor? I recommend that you look into PET's fundamental factors such as its current valuation and financial health as well. 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. PET 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 Peat Resources 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 Peat Resources 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.
