One Thing To Consider Before Buying Champion Iron Limited (ASX:CIA)

If you are looking to invest in Champion Iron Limited’s (ASX:CIA), 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. Broadly speaking, there are two types of risk you should consider when investing in stocks such as CIA. The first risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as CIA, because it is rare that an entire industry collapses at once. 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.

Not every stock is exposed to the same level 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. 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 CIA’s market risk?

Champion Iron’s five-year beta of 2.08 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, CIA 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.

Does CIA's size and industry impact the expected beta?

With a market cap of A$596.07M, CIA falls within the small-cap spectrum of stocks, which are found to experience higher relative risk compared to larger companies. Furthermore, the company operates in the metals and mining 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 supports our interpretation of CIA’s beta value discussed above. Fundamental factors can also drive the cyclicality of the stock, which we will take a look at next.

Can CIA's asset-composition point to a higher 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 CIA’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. CIA'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 CIA 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 may reap the gains of CIA'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 Champion Iron’s financial health and performance track record. I highly recommend you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for CIA’s future growth? Take a look at our free research report of analyst consensus for CIA’s outlook.

2. Past Track Record: Has CIA 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 CIA's historicals for more clarity.

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.