Should You Have Mercia Technologies PLC’s (AIM:MERC) In Your Portfolio?

For Mercia Technologies PLC’s (AIM:MERC) 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 MERC. The first risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as MERC, 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.

Not every stock is exposed to the same level 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. 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.

See our latest analysis for MERC

What is MERC’s market risk?

With a five-year beta of 0.68, Mercia Technologies 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. MERC’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.

AIM:MERC Income Statement Nov 28th 17
AIM:MERC Income Statement Nov 28th 17

Could MERC’s size and industry cause it to be more volatile?

With a market cap of GBP £103.33M, MERC falls within the small-cap spectrum of stocks, which are found to experience higher relative risk compared to larger companies. Moreover, MERC’s industry, capital markets, is considered to be cyclical, which means it is more volatile than the market over the economic cycle. As a result, we should expect a high beta for the small-cap MERC but a low beta for the capital markets industry. This is an interesting conclusion, since both MERC’s size and industry indicates the stock should have a higher beta than it currently has. There may be a more fundamental driver which can explain this inconsistency, which we will examine below.

How MERC’s assets could affect its beta

During times of economic downturn, low demand may cause companies to readjust production of their goods and services. It is more difficult for companies to lower their cost, if the majority of these costs are generated by fixed assets. Therefore, this is a type of risk which is associated with higher beta. I examine MERC’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. Considering fixed assets is virtually non-existent in MERC’s operations, it has low dependency on fixed costs to generate revenue. Thus, we can expect MERC 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. 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 MERC. 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? You should consider the stock in terms of your portfolio. It could be a valuable addition in times of an economic decline, due to its low fixed cost and low beta. However, I recommend you to also look at its fundamental factors as well, such as its current valuation and financial health to assess its investment thesis in further detail.

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