If you are a shareholder in China Fire Safety Enterprise Group Limited’s (SEHK:445), 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 445. 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 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 considered more sensitive to market-wide shocks compared to a stock that trades below the value of one.See our latest analysis for China Fire Safety Enterprise Group
What is 445’s market risk?
With a five-year beta of 0.58, China Fire Safety Enterprise Group appears to be a less volatile company compared to the rest of the market. The stock will exhibit muted movements in both the downside and upside, in response to changing economic conditions, whereas the general market may move by a lot more. 445’s beta implies it may be a stock that investors with high-beta portfolios might find relevant if they wanted to reduce their exposure to market risk, especially during times of downturns.
Could 445’s size and industry cause it to be more volatile?
With a market cap of HK$1.59B, 445 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 machinery industry, which has been found to have high sensitivity to market-wide shocks. As a result, we should expect a high beta for the small-cap 445 but a low beta for the machinery industry. This is an interesting conclusion, since both 445’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.
Is 445’s cost structure indicative of a high 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 445’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. Since 445’s fixed assets are only 21.72% of its total assets, it doesn’t depend heavily on a high level of these rigid and costly assets to operate its business. 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 445. Its low fixed cost also means that, in terms of operating leverage, it is relatively flexible during times of economic downturns. What I have not mentioned in my article here are important company-specific fundamentals such as China Fire Safety Enterprise Group’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 445’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 445 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 445’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.