Why You Need To Look At This Factor Before Buying Petrel Resources Plc (LON:PET)

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 risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as PET, because it is rare that an entire industry collapses at once. 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.

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. 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.

An interpretation of PET's beta

Petrel Resources’s beta of 0.78 indicates that the company is less volatile relative to the diversified market portfolio. 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. PET’s beta indicates it is a stock that investors may find valuable if they want to reduce the overall market risk exposure of their stock portfolio.

Could PET's size and industry cause it to be more volatile?

A market capitalisation of £2.49M 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.

How PET'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 PET’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of 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. 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. This is consistent with is current beta value which also indicates low volatility.

What this means for you:

You could benefit from lower risk during times of economic decline by holding onto PET. Take into account your portfolio sensitivity to the market before you invest in the stock, as well as where we are in the current economic cycle. Depending on the composition of your portfolio, PET may be a valuable stock to hold onto in order to cushion the impact of a downturn. In order to fully understand whether XYZ is a good investment for you, we also need to consider important company-specific fundamentals such as Petrel Resources’s financial health and performance track record. I highly recommend you to complete your research by taking a look at the following:

1. 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.

2. 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.

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.