How Does TAG Oil Ltd (TSE:TAO) Affect Your Portfolio Returns?

If you are looking to invest in TAG Oil Ltd’s (TSX:TAO), 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 TAO. The first risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as TAO, because it is rare that an entire industry collapses at once. 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. 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 expected to exhibit higher volatility resulting from market-wide shocks compared to one with a beta below one.

What is TAO’s market risk?

TAG Oil’s five-year beta of 1.6 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, TAO 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.

How does TAO's size and industry impact its risk?

TAO, with its market capitalisation of CA$29.85M, is a small-cap stock, which generally have higher beta than similar companies of larger size. Moreover, TAO’s industry, oil and gas, 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 TAO’s beta value discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.

How TAO'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 test TAO’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%, TAO 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 TAO indicates a higher beta than a similar size company with a lower portion of fixed assets on their balance sheet. This is consistent with is current beta value which also indicates high volatility.

What this means for you:

You may reap the gains of TAO'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 TAG Oil’s financial health and performance track record. I urge you to complete your research by taking a look at the following:

1. Financial Health: Is TAO’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.
2. Past Track Record: Has TAO 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 TAO'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.