If you are a shareholder in Recon Technology Ltd’s (NASDAQ:RCON), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. Broadly speaking, there are two types of risk you should consider when investing in stocks such as RCON. The first risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as RCON, 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. 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 RCON's beta value mean?
Recon Technology’s five-year beta of 1.99 means that the company’s value will swing up by more than the market during prosperous times, but also drop down by more in times of downturns. This level of volatility indicates bigger risk for investors who passively invest in the stock market index. According to this value of beta, RCON will help diversify your portfolio, if it currently comprises of low-beta stocks. This will be beneficial for portfolio returns, in particular, when current market sentiment is positive.
Could RCON's size and industry cause it to be more volatile?
With a market cap of USD $7.17M, RCON 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. Therefore, investors may expect high beta associated with small companies, as well as those operating in the X industry, relative to those more well-established firms in a more defensive industry. This supports our interpretation of RCON’s beta value discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.
How RCON'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 RCON’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Since RCON’s fixed assets are only 7.51% 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 RCON 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 RCON’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 RCON. 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 RCON.
Are you a potential investor? I recommend that you look into RCON'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. RCON 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 Recon Technology 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 Recon Technology 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.