For Toro Energy Limited’s (ASX:TOE) shareholders, and also potential investors in the stock, understanding how the stock’s risk and return characteristics can impact your portfolio is important. Broadly speaking, there are two types of risk you should consider when investing in stocks such as TOE. The first risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as TOE, because it is rare that an entire industry collapses at once. 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 all stocks are expose to the same level of market risk. A widely-used metric to measure a stock’s market risk is beta, and the broad market index 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.See our latest analysis for TOE
An interpretation of TOE’s beta
With a beta of 1.26, Toro Energy is a stock that tends to experience more gains than the market during a growth phase and also a bigger reduction in value compared to the market during a broad downturn. Based on this beta value, TOE 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.
Does TOE’s size and industry impact the expected beta?
A market capitalisation of AUD A$66.27M puts TOE in the category of small-cap stocks, which tends to possess higher beta than larger companies. In addition to size, TOE also operates in the oil, gas and consumable fuels industry, which has commonly demonstrated strong reactions to market-wide shocks. So, investors should expect a larger beta for smaller companies operating in a cyclical industry in contrast with lower beta for larger firms in a more defensive industry. This is consistent with TOE’s individual beta value we discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.
Can TOE’s asset-composition point to a higher 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 TOE’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Given a fixed to total assets ratio of over 30%, TOE seems to be a company which invests a big chunk of its capital on assets that cannot be scaled down on short-notice. As a result, this aspect of TOE indicates a higher beta than a similar size company with a lower portion of fixed assets on their balance sheet. This is consistent with is current beta value which also indicates high volatility.
What this means for you:
Are you a shareholder? You could benefit from higher returns from TOE 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 TOE, 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 TOE.
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 Toro 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 Toro Energy anymore, you can use our free platform to see my list of over 50 other stocks with a high growth potential.