If you are a shareholder in Metminco Limited’s (ASX:MNC), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. Every stock in the market is exposed to market risk, which arises from macroeconomic factors such as economic growth and geo-political tussles just to name a few. This is measured by its beta. Different characteristics of a stock expose it to various levels of market risk, 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.
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What is MNC’s market risk?
Metminco’s beta of 0.57 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. MNC’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 MNC’s size and industry cause it to be more volatile?
A market capitalisation of AUD A$6.04M puts MNC in the category of small-cap stocks, which tends to possess higher beta than larger companies. Moreover, MNC’s industry, metals and mining, 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 metals and mining 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 MNC’s size and industry relative to its actual beta value. There may be a more fundamental driver which can explain this inconsistency, which we will examine below.
How MNC’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 test MNC’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. MNC’s fixed assets to total assets ratio of higher than 30% shows that the company uses up a big chunk of its capital on assets that are hard to scale up or down in short notice. Thus, we can expect MNC to be more volatile in the face of market movements, relative to its peers of similar size but with a lower proportion of fixed assets on their books. However, this is the opposite to what MNC’s actual beta value suggests, which is lower stock volatility relative to the market.