Why You Need To Look At This Factor Before Buying STM Group Plc (LON:STM)

If you are a shareholder in STM Group Plc’s (AIM:STM), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. Generally, an investor should consider two types of risk that impact the market value of STM. The first risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as STM, 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 all stocks are expose 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 does STM's beta value mean?

With a five-year beta of 0.52, STM Group appears to be a less volatile company compared to the rest of the market. This means that the change in STM's value, whether it goes up or down, will be of a smaller degree than the change in value of the entire stock market index. Based on this beta value, STM appears to be a stock that an investor with a high-beta portfolio would look for to reduce risk exposure to the market.

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

A market capitalisation of UK£29.38M puts STM in the category of small-cap stocks, which tends to possess higher beta than larger companies. Moreover, STM’s industry, capital markets, is considered to be cyclical, which means it is more volatile than the market over the economic cycle. As a result, we should expect a high beta for the small-cap STM but a low beta for the capital markets industry. This is an interesting conclusion, since both STM’s size and industry indicates the stock should have a higher beta than it currently has. A potential driver of this variance can be a fundamental factor, which we will take a look at next.

How STM'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 examine STM’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. Given that fixed assets make up less than a third of the company’s total assets, STM doesn’t rely heavily upon these expensive, inflexible assets to run its business during downturns. As a result, the company may be less volatile relative to broad market movements, compared to a company of similar size but higher proportion of fixed assets. Similarly, STM’s beta value conveys the same message.

What this means for you:

You could benefit from lower risk during times of economic decline by holding onto STM. Its low fixed cost also means that, in terms of operating leverage, it is relatively flexible during times of economic downturns. In order to fully understand whether STM is a good investment for you, we also need to consider important company-specific fundamentals such as STM Group’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 STM’s future growth? Take a look at our free research report of analyst consensus for STM’s outlook.
2. Past Track Record: Has STM 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 STM'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.