How Does Investing In Africa Oil Corp (TSX:AOI) Impact Your Portfolio?

If you are a shareholder in Africa Oil Corp’s (TSX:AOI), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. Generally, an investor should consider two types of risk that impact the market value of AOI. The first risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as AOI, because it is rare that an entire industry collapses at once. The second risk is market-wide, which arises from investing in the stock market. This risk reflects changes in economic and political factors that affects all stocks.

Different characteristics of a stock expose it to various levels of market risk. The most widely used metric to quantify a stock’s market risk is beta, and the market as a whole represents a beta 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.

View our latest analysis for Africa Oil

What does AOI’s beta value mean?

Africa Oil has a beta of 2.98, which means that the percentage change in its stock value will be higher than the entire market in times of booms and busts. A high level of beta means investors face higher risk associated with potential gains and losses driven by market movements. According to this value of beta, AOI 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.

TSX:AOI Income Statement Nov 2nd 17
TSX:AOI Income Statement Nov 2nd 17

How does AOI’s size and industry impact its risk?

AOI, with its market capitalisation of CAD CA$744.29M, is a small-cap stock, which generally have higher beta than similar companies of larger size. Moreover, AOI’s industry, oil, gas and consumable fuels, is considered to be cyclical, which means it is more volatile than the market over the economic cycle. 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. This is consistent with AOI’s individual beta value we discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.

How AOI’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 AOI’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 an insignificant portion of total assets, AOI doesn’t rely heavily upon these expensive, inflexible assets to run its business during downturns. Thus, we can expect AOI 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. However, this is the opposite to what AOI’s actual beta value suggests, which is higher stock volatility relative to the market.

What this means for you:

Are you a shareholder? You could benefit from higher returns during times of economic growth by holding onto AOI. 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 AOI.

Are you a potential investor? Before you buy AOI, you should take into account how their portfolio currently moves with the market, in addition to the current economic environment. AOI may be a valuable addition to portfolios during times of economic growth, and it may be work looking further into fundamental factors such as current valuation and financial health.

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 Africa Oil 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 Africa Oil anymore, you can use our free platform to see my list of over 50 other stocks with a high growth potential.