For Empire Energy Group Limited’s (ASX:EEG) shareholders, and also potential investors in the stock, understanding how the stock’s risk and return characteristics can impact your portfolio is important. Generally, an investor should consider two types of risk that impact the market value of EEG. The first risk to think about is company-specific, which can be diversified away by investing in other companies in order to lower your exposure to one particular stock. 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.
Different characteristics of a stock expose it to various levels 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 Empire Energy Group
What is EEG’s market risk?
With a beta of 1.78, Empire Energy Group 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. According to this value of beta, EEG 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.
How does EEG’s size and industry impact its risk?
A market capitalisation of US$41.75m puts EEG in the category of small-cap stocks, which tends to possess higher beta than larger companies. Furthermore, the company operates in the oil and gas industry, which has been found to have high sensitivity to market-wide shocks. As a result, we should expect higher beta for small-cap stocks in a cyclical industry compared to larger stocks in a defensive industry. This is consistent with EEG’s individual beta value we discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.
How EEG’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 EEG’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. With a fixed-assets-to-total-assets ratio of greater than 30%, EEG appears to be a company that invests a large amount of capital in assets that are hard to scale down on short-notice. As a result, this aspect of EEG indicates a higher beta than a similar size company with a lower portion of fixed assets on their balance sheet. Similarly, EEG’s beta value conveys the same message.
What this means for you:
You could benefit from higher returns from EEG during times of economic growth. Its higher fixed cost isn’t a major concern given margins are covered with high consumer demand. Though, in times of a downturn, it may be safe to look at a more defensive stock which can cushion the impact of lower demand. What I have not mentioned in my article here are important company-specific fundamentals such as Empire Energy Group’s financial health and performance track record. I urge you to complete your research by taking a look at the following:
- Financial Health: Is EEG’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.
- Past Track Record: Has EEG been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of EEG’s historicals for more clarity.
- 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.