Does a Stock’s Price Influence Its Risk Profile?

As a inventory’s nominal share value falls, what occurs to its threat profile? The reply to this query has vital implications for managing investor expectations and decreasing portfolio turnover. Afterall, traders usually deviate from their chosen long-term methods attributable to emotional reactions to unanticipated market actions. These market-timing actions current their own form of risk, including to the prevailing threat of unpredictable markets.

Some would argue that as a inventory approaches the decrease finish of penny inventory territory, volatility will reasonable as a result of there’s an inherent threshold beneath which the worth can not drop. Others would contend that the inventory will develop into extra delicate to market actions as a result of market situations dictate the survival of the corporate.

We investigated what occurs to systematic threat and the whole volatility of a inventory when it turns into a penny inventory, i.e., its value drops beneath $5 per share. The outcomes might shock you. We discovered that as a inventory declines in worth, it turns into extra delicate to market actions. In different phrases, its beta will increase and its whole volatility will increase accordingly.

We pulled inventory returns on all NASDAQ- and NYSE-listed corporations going again 50 years. We examined shares that through the 50-year interval crossed the edge of $1 a share, $2.50 a share, or $5 a share. We captured the cases when every inventory crossed these thresholds for the primary time. We then famous the beta of the shares earlier than the edge crossovers and in contrast them to the identical betas of the shares two years after the crossover date.

The Findings

The primary fascinating discovering is that when a inventory dips beneath the $1 threshold, on common, its beta goes from 0.93 to 1.57. A beta better than 1.0 means a inventory’s value is extra risky than the general market, i.e., its value swings extra wildly. The other is true of a beta lower than 1.0.

The bounce in beta to 1.57 from 0.93 for the shares that dipped beneath the $1 threshold represents a major shift in threat profiles. In actual fact, it’s statistically important at 1%. On the $1 threshold, the typical penny inventory has far more systematic threat and whole volatility. And this shift is throughout the board. Shares with adverse betas go from a median of -0.62 to 1.14. Shares with betas between 0 and 1.0 go from 0.55 to 1.37. And shares with betas greater than 1.0 go from 1.95 to 1.88.

What occurs to systematic threat and the whole volatility of a inventory when it turns into a penny inventory:

The outcomes spotlight that this drastic improve in threat (volatility) is totally attributable to will increase in systematic threat, i.e., motion with the market index. Notably, these outcomes should not pushed by a reversion to the imply over time in betas.

On the excessive finish of our examine, we examined when shares cross the $5 a share barrier. The outcomes look fairly completely different. Earlier than a inventory crossed the $5 threshold, on common, its beta is 1.0 and afterward it’s 1.07.  The opposite beta tiers at $5 a share confirmed the identical outcomes. This affirms that the $1 threshold outcomes are really as a result of inventory getting into penny inventory territory.

The outcomes assist the concept that penny shares develop into far more dangerous (greater volatility) as they strategy the zero-price barrier and that this threat is because of will increase in systematic threat (elevated sensitivity to market actions).

When you preferred this publish, don’t neglect to subscribe to the Enterprising Investor.

All posts are the opinion of the creator. As such, they shouldn’t be construed as funding recommendation, nor do the opinions expressed essentially mirror the views of CFA Institute or the creator’s employer.

Skilled Studying for CFA Institute Members

CFA Institute members are empowered to self-determine and self-report skilled studying (PL) credit earned, together with content material on Enterprising Investor. Members can document credit simply utilizing their online PL tracker.