If you are looking to invest in Santos Limited’s (ASX:STO), or currently own the stock, then you need to understand its beta in order to understand how it can affect the risk of your portfolio. There are two types of risks that affect the market value of a listed company such as STO. The first risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as STO, 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. 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. A stock with a beta greater than one is considered more sensitive to market-wide shocks compared to a stock that trades below the value of one.View our latest analysis for Santos
An interpretation of STO’s beta
Santos’s five-year beta of 1.96 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, STO 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.
Does STO’s size and industry impact the expected beta?
STO has a market capitalization of AU$12.91B, putting it in the category of established companies, which are found to experience less relative risk compared to small-sized companies. However, STO operates in the oil and gas industry, which has commonly demonstrated strong reactions to market-wide shocks. Therefore, investors can expect a low beta associated with the size of STO, but a higher beta given the nature of the industry it operates in. It seems as though there is an inconsistency in risks from STO’s size and industry. There may be a more fundamental driver which can explain this inconsistency, which we will examine below.
Is STO’s cost structure indicative of a high 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 test STO’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%, STO 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 STO 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, STO’s beta value conveys the same message.
What this means for you:
You may reap the gains of STO’s returns in times of an economic boom. Though the business does have higher fixed cost than what is considered safe, during times of growth, consumer demand may be high enough to not warrant immediate concerns. However, during a downturn, a more defensive stock can cushion the impact of this risk. What I have not mentioned in my article here are important company-specific fundamentals such as Santos’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 STO’s future growth? Take a look at our free research report of analyst consensus for STO’s outlook.
- Past Track Record: Has STO 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 STO’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.