Does NAOS Absolute Opportunities Company Limited (ASX:NAC) Fall With The Market?

If you are a shareholder in NAOS Absolute Opportunities Company Limited’s (ASX:NAC), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. Broadly speaking, there are two types of risk you should consider when investing in stocks such as NAC. The first risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as NAC, 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 every stock is exposed 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. 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.

An interpretation of NAC's beta

NAOS Absolute Opportunities's beta of 0.15 indicates that the stock value will be less variable compared to the whole stock 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. NAC'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.

How does NAC's size and industry impact its risk?

NAC, with its market capitalisation of AU$52.54M, is a small-cap stock, which generally have higher beta than similar companies of larger size. Moreover, NAC’s industry, capital markets, 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 capital markets 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 NAC’s size and industry relative to its actual beta value.

How NAC'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 test NAC’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Considering fixed assets is virtually non-existent in NAC's operations, it has low 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. Similarly, NAC’s beta value conveys the same message.

What this means for you:

You could benefit from lower risk during times of economic decline by holding onto NAC. 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. Depending on the composition of your portfolio, NAC may be a valuable stock to hold onto in order to cushion the impact of a downturn. What I have not mentioned in my article here are important company-specific fundamentals such as NAOS Absolute Opportunities’s financial health and performance track record. I urge you to complete your research by taking a look at the following:

1. Financial Health: Is NAC’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
2. Valuation: What is NAC worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether NAC is currently mispriced by the market.
3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.