What You Must Know About ADX Energy Ltd’s (ASX:ADX) Risks

For ADX Energy Ltd’s (ASX:ADX) shareholders, and also potential investors in the stock, understanding how the stock’s risk and return characteristics can impact your portfolio is important. There are two types of risks that affect the market value of a listed company such as ADX. 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 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. 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.

See our latest analysis for ADX

An interpretation of ADX’s beta

With a beta of 3.14, ADX 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, ADX 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.

ASX:ADX Income Statement Oct 12th 17
ASX:ADX Income Statement Oct 12th 17

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

ADX, with its market capitalisation of AUD $15.37M, is a small-cap stock, which generally have higher beta than similar companies of larger size. Moreover, ADX’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. 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 supports our interpretation of ADX’s beta value discussed above. Fundamental factors can also drive the cyclicality of the stock, which we will take a look at next.

Can ADX’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 examine ADX’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 account for less than a third of the company’s overall assets, ADX seems to have a smaller dependency on fixed costs to generate revenue. 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. However, this is the opposite to what ADX’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 ADX. 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 ADX.

Are you a potential investor? I recommend that you look into ADX’s fundamental factors such as its current valuation and financial health. Take into account your portfolio sensitivity to the market before you invest in the stock, as well as where we are in the current economic cycle. ADX may be a great investment during times of economic growth.

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