Solution Dynamics Limited (NZE:SDL): Risks You Need To Consider Before Buying

If you are a shareholder in Solution Dynamics Limited’s (NZSE:SDL), 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 SDL. 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. 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.

What does SDL's beta value mean?

Solution Dynamics’s beta of 0.12 indicates that the company is less volatile relative to the diversified market portfolio. 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. SDL'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 SDL's size and industry cause it to be more volatile?

SDL, with its market capitalisation of NZ$28.34M, is a small-cap stock, which generally have higher beta than similar companies of larger size. Furthermore, the company operates in the it services industry, which has been found to have high sensitivity to market-wide shocks. Therefore, investors may expect high beta associated with small companies, as well as those operating in the it services industry, relative to those more well-established firms in a more defensive industry. This is an interesting conclusion, since both SDL’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 SDL's assets could affect its 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 examine SDL’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 SDL’s fixed assets are only 12.23% 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. Similarly, SDL’s beta value conveys the same message.

What this means for you:

You may reap the benefit of muted movements during times of economic decline by holding onto SDL. Its low fixed cost also means that, in terms of operating leverage, its costs are relatively malleable to preserve margins. What I have not mentioned in my article here are important company-specific fundamentals such as Solution Dynamics’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 SDL’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 SDL 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 SDL'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.