If you are looking to invest in African Energy Resources Limited's ( ASX:AFR ), 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. The beta measures AFR's exposure to the wider market risk, which reflects changes in economic and political factors. Different characteristics of a stock expose it to various levels of market risk, 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.
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What is AFR's market risk?
African Energy Resources's five-year beta of 1.21 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. Based on this beta value, AFR 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 AFR's size and industry cause it to be more volatile?
A market capitalisation of AUD $26.95M puts AFR in the category of small-cap stocks, which tends to possess higher beta than larger companies. Furthermore, the company operates in the oil, gas and consumable fuels 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 supports our interpretation of AFR's beta value discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.
How AFR'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 examine AFR's ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. Given a fixed to total assets ratio of over 30%, AFR 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 AFR 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, AFR's beta value conveys the same message.
What this means for you:
Are you a shareholder?You could benefit from higher returns from AFR during times of economic growth. Its higher fixed cost isn't a major concern given margins are covered with high consumer demand. However, in times of a downturn, it may be safe to look at a more defensive stock which can cushion the impact of lower demand.
Are you a potential investor?Before you buy AFR, you should factor how your portfolio currently moves with the wider market, and where we are in the economic cycle. This stock could be an outperformer during times of growth, and it may be worth taking a deeper dive into the fundamentals to crystalize your thoughts on AFR.
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 African Energy 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 African Energy 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.
