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Anyone researching Chongqing Machinery & Electric Co., Ltd. (HKG:2722) might want to consider the historical volatility of the share price. Modern finance theory considers volatility to be a measure of risk, and there are two main types of price volatility. The first type is company specific volatility. Investors use diversification across uncorrelated stocks to reduce this kind of price volatility across the portfolio. The other type, which cannot be diversified away, is the volatility of the entire market. Every stock in the market is exposed to this volatility, which is linked to the fact that stocks prices are correlated in an efficient market.
Some stocks see their prices move in concert with the market. Others tend towards stronger, gentler or unrelated price movements. Beta can be a useful tool to understand how much a stock is influenced by market risk (volatility). However, Warren Buffett said ‘volatility is far from synonymous with risk’ in his 2014 letter to investors. So, while useful, beta is not the only metric to consider. To use beta as an investor, you must first understand that the overall market has a beta of one. A stock with a beta greater than one is more sensitive to broader market movements than a stock with a beta of less than one.
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What 2722’s beta value tells investors
Looking at the last five years, Chongqing Machinery & Electric has a beta of 1.11. The fact that this is well above 1 indicates that its share price movements have shown sensitivity to overall market volatility. If the past is any guide, we would expect that Chongqing Machinery & Electric shares will rise quicker than the markets in times of optimism, but fall faster in times of pessimism. Share price volatility is well worth considering, but most long term investors consider the history of revenue and earnings growth to be more important. Take a look at how Chongqing Machinery & Electric fares in that regard, below.
How does 2722’s size impact its beta?
Chongqing Machinery & Electric is a rather small company. It has a market capitalisation of HK$2.1b, which means it is probably under the radar of most investors. Relatively few investors can influence the price of a smaller company, compared to a large company. This could explain the high beta value, in this case.