If you are a shareholder in Matrix Composites & Engineering Ltd’s (ASX:MCE), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. There are two types of risks that affect the market value of a listed company such as MCE. 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 type is market risk, one that you cannot diversify away, since it arises from macroeconomic factors which directly affects all the stocks in the market.
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.
What is MCE’s market risk?
Matrix Composites & Engineering’s five-year beta of 1.74 means that the company’s value will swing up by more than the market during prosperous times, but also drop down by more in times of downturns. This level of volatility indicates bigger risk for investors who passively invest in the stock market index. Based on this beta value, MCE can help magnify your portfolio return, especially if it is predominantly made up of low-beta stocks. If the market is going up, a higher exposure to the upside from a high-beta stock can push up your portfolio return.
Could MCE’s size and industry cause it to be more volatile?
A market capitalisation of AU$44.06m puts MCE in the category of small-cap stocks, which tends to possess higher beta than larger companies. Moreover, MCE’s industry, energy services, is considered to be cyclical, which means it is more volatile than the market over the economic cycle. 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 supports our interpretation of MCE’s beta value discussed above. Fundamental factors can also drive the cyclicality of the stock, which we will take a look at next.
How MCE’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 MCE’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. With a fixed-assets-to-total-assets ratio of greater than 30%, MCE appears to be a company that invests a large amount of capital in assets that are hard to scale down on short-notice. Thus, we can expect MCE to be more volatile in the face of market movements, relative to its peers of similar size but with a lower proportion of fixed assets on their books. Similarly, MCE’s beta value conveys the same message.
What this means for you:
You could benefit from higher returns from MCE 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. In order to fully understand whether MCE is a good investment for you, we also need to consider important company-specific fundamentals such as Matrix Composites & Engineering’s financial health and performance track record. I urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for MCE’s future growth? Take a look at our free research report of analyst consensus for MCE’s outlook.
- Past Track Record: Has MCE 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 MCE’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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.