If you are a shareholder in Galilee Energy Limited’s (ASX:GLL), 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 GLL. The first risk to think about is company-specific, which can be diversified away by investing in other companies in order to lower your exposure to one particular stock. The second type is market risk, one that you cannot diversify away, since it arises from macroeconomic factors which directly affects all the stocks in the market.
Different characteristics of a stock expose it to various levels 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 considered more sensitive to market-wide shocks compared to a stock that trades below the value of one.See our latest analysis for GLL
What does GLL’s beta value mean?
With a five-year beta of 0.07, Galilee Energy appears to be a less volatile company compared to the rest of the market. The stock will exhibit muted movements in both the downside and upside, in response to changing economic conditions, whereas the general market may move by a lot more. Based on this beta value, GLL appears to be a stock that an investor with a high-beta portfolio would look for to reduce risk exposure to the market.
How does GLL’s size and industry impact its risk?
With a market cap of AUD A$33.63M, GLL 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 oil, gas and consumable fuels 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 oil, gas and consumable fuels industry, relative to those more well-established firms in a more defensive industry. It seems as though there is an inconsistency in risks portrayed by GLL’s size and industry relative to its actual beta value. A potential driver of this variance can be a fundamental factor, which we will take a look at next.
Is GLL’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 examine GLL’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 that fixed assets make up less than a third of the company’s total assets, GLL doesn’t rely heavily upon these expensive, inflexible assets to run its business during downturns. Thus, we can expect GLL 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. Similarly, GLL’s beta value conveys the same message.
What this means for you:
Are you a shareholder? You could benefit from lower risk during times of economic decline by holding onto GLL. 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 GLL.
Are you a potential investor? Before you buy GLL, you should look at the stock in conjunction with their current portfolio holdings. GLL 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 Galilee Energy 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 Galilee Energy anymore, you can use our free platform to see my list of over 50 other stocks with a high growth potential.