For Verona Pharma plc's ( AIM:VRP ) shareholders, and also potential investors in the stock, understanding how the stock's risk and return characteristics can impact your portfolio is important. Generally, an investor should consider two types of risk that impact the market value of VRP. 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 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 popular measure of market risk for a stock is its beta, and the market as a whole 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.
Check out our latest analysis for Verona Pharma
What is VRP's market risk?
Verona Pharma's beta of 0.04 indicates that the stock value will be less variable compared to the whole stock market. 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. VRP's beta implies it may be a stock that investors with high-beta portfolios might find relevant if they wanted to reduce their exposure to market risk, especially during times of downturns.
Could VRP's size and industry cause it to be more volatile?
With a market cap of GBP £159.95M, VRP falls within the small-cap spectrum of stocks, which are found to experience higher relative risk compared to larger companies. However, VRP operates in the pharmaceuticals, biotechnology and life sciences industry, which has commonly demonstrated muted reactions to market-wide shocks. Therefore, investors can expect a high beta associated with the size of VRP, but a lower beta given the nature of the industry it operates in. This is an interesting conclusion, since its size suggests VRP should be more volatile than it actually is. There may be a more fundamental driver which can explain this inconsistency, which we will examine below.
Is VRP's cost structure indicative of a high 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 VRP's ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Given that fixed assets make up less than a third of the company's total assets, VRP doesn't rely heavily upon these expensive, inflexible assets to run its business during downturns. As a result, the company may be less volatile relative to broad market movements, compared to a company of similar size but higher proportion of fixed assets. This is consistent with is current beta value which also indicates low volatility.
What this means for you:
Are you a shareholder?You may reap the benefit of muted movements during times of economic decline by holding onto VRP. Its low fixed cost also means that, in terms of operating leverage, its costs are relatively malleable to preserve margins. I recommend analysing the stock in terms of your current portfolio composition before increasing your exposure to the stock.
Are you a potential investor?Before you buy VRP, you should look at the stock in conjunction with their current portfolio holdings. VRP may be a great cushion during times of economic downturns due to its low beta and low fixed cost. However, in addition to this, I recommend taking into account its fundamentals as well before jumping 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 Verona Pharma 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 Verona Pharma 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.
