‘Be-ta’ is one of those Greek-letter named metrics that Wall Street pros love to talk about when they want to sound smart. But it’s a simple concept. Beta reflects how volatile a stock is. High beta means more volatile while low means less volatile, compared to the overall market.
Many investors are more familiar with value or growth stocks, either through their funds or individual stock names: growth stocks such as Google parent Alphabet (GOOG), Amazon (AMZN), Meta (FB) and other tech giants; big value names including Berkshire Hathaway (BRK.B) and Johnson & Johnson (JNJ). But strategists say that the challenge right now is that, amid the uncertainty about the economic outlook, it’s even harder than usual to say whether the environment will favor growth or value.
Coming into 2022, many growth stocks especially technology names—were trading at lofty valuations thanks to their perception as a haven during the pandemic-sparked recession. Those high valuations left them vulnerable to any significant changes in outlook for the economy. For growth stocks, valuations are based heavily on expectations of future earnings, and future earnings for many companies can be affected by the pace of economic growth.
The appeal of dividends may also tempt investors towards value stocks. The average dividend yield of the value index is more than 3%.
Navigating the landscape from a factor-based approach has yielded less choppiness and more consistency, even in sectors that may not be considered growth- or value-oriented. For example, value factors have performed quite well in the growth-oriented Tech sector. Meanwhile Tech sector consistently recording high free cash flow yield has outperformed the growth factor of long-term estimated earnings growth by a wide margin since the beginning of 2021 in the tech though the median of value and growth are converging in the past couple of months.
Having said that, the relative performance also depends on the prospects for growth stocks, which face two ongoing uncertainties. Firstly, the earnings prospects of companies in this category are particularly hard to forecast right now. Secondly, it remains a risk that interest rates rise further if economic activity and/or inflation rise further which has the potential to weigh on longer-duration growth stocks.
As a thumb rule, Investments with a beta greater than 1.00 tend to be more sensitive to market movements, while investments with a beta lower than 1.00 tend not to react given the broader-
High-beta stocks can often be found within the sector, a grouping of stocks from industries that are highly impacted by economic shifts. Investors might assume that technology stocks are the highest beta group, but for the 10-year trailing period, the group ranks fourth, behind energy, consumer cyclical, and basic materials. (These rankings can shift when looking over different time frames. For the past year, energy stocks have been very low beta.). It’s very clear when considering the historical probabilities: bad news is, often, a good sign for the [consumer cyclical] sector.
Finally, a broad sell-off is also providing selective opportunities to obtain good growth companies at better prices. The challenge for investors will be to find compelling innovative companies without overpaying.
