If you are a shareholder in Toro Energy Limited’s (ASX:TOE), 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 TOE. 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 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.
Different characteristics of a stock expose it to various levels 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.View our latest analysis for Toro Energy
What is TOE’s market risk?
Toro Energy’s five-year beta of 1.32 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. According to this value of beta, TOE may be a stock for investors with a portfolio mainly made up of low-beta stocks. This is because during times of bullish sentiment, you can reap more of the upside with high-beta stocks compared to muted movements of low-beta holdings.
Does TOE’s size and industry impact the expected beta?
TOE, with its market capitalisation of AU$58.23M, is a small-cap stock, which generally have higher beta than similar companies of larger size. In addition to size, TOE also operates in the oil and gas industry, which has commonly demonstrated strong reactions to market-wide shocks. Therefore, investors may expect high beta associated with small companies, as well as those operating in the oil and gas industry, relative to those more well-established firms in a more defensive industry. This is consistent with TOE’s individual beta value we discussed above. Fundamental factors can also drive the cyclicality of the stock, which we will take a look at next.
How TOE’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 TOE’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. TOE’s fixed assets to total assets ratio of higher than 30% shows that the company uses up a big chunk of its capital on assets that are hard to scale up or down in short notice. Thus, we can expect TOE 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. This is consistent with is current beta value which also indicates high volatility.
What this means for you:
You could benefit from higher returns from TOE 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 TOE is a good investment for you, we also need to consider important company-specific fundamentals such as Toro Energy’s financial health and performance track record. I highly recommend you to complete your research by taking a look at the following:
- Financial Health: Is TOE’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 TOE 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 TOE’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.