If you are a shareholder in Petrel Resources Plc’s (AIM:PET), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. There are two types of risks that affect the market value of a listed company such as PET. The first type is company-specific risk, which can be diversified away by investing in other companies to reduce exposure to one particular stock. 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.
Different characteristics of a stock expose it to various levels 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.See our latest analysis for Petrel Resources
What does PET’s beta value mean?
With a five-year beta of 0.69, Petrel Resources appears to be a less volatile company compared to the rest of the market. This means that the change in PET’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, PET appears to be a stock that an investor with a high-beta portfolio would look for to reduce risk exposure to the market.
Could PET’s size and industry cause it to be more volatile?
A market capitalisation of UK£2.34M puts PET in the category of small-cap stocks, which tends to possess higher beta than larger companies. Moreover, PET’s industry, oil and gas, is considered to be cyclical, which means it is more volatile than the market over the economic cycle. 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. It seems as though there is an inconsistency in risks portrayed by PET’s size and industry relative to its actual beta value.
Is PET’s cost structure indicative of a high 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 PET’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Considering fixed assets is virtually non-existent in PET’s operations, it has low dependency on fixed costs to generate revenue. Thus, we can expect PET to be more stable in the face of market movements, relative to its peers of similar size but with a higher portion of fixed assets on their books. Similarly, PET’s beta value conveys the same message.
What this means for you:
PET may be a worthwhile stock to hold onto in order to cushion the impact of a downturn. Depending on the composition of your portfolio, low-beta stocks such as PET is valuable to lower your risk of market exposure, in particular, during times of economic decline. What I have not mentioned in my article here are important company-specific fundamentals such as Petrel Resources’s financial health and performance track record. I urge you to complete your research by taking a look at the following:
- Financial Health: Is PET’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 PET 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 PET’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.