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If you are a shareholder in Empyrean Energy Plc’s (AIM:EME), 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. Not all stocks are expose to the same level 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.
See our latest analysis for Empyrean Energy
An interpretation of EME’s beta
With a beta of 1.96, Empyrean Energy is a stock that tends to experience more gains than the market during a growth phase and also a bigger reduction in value compared to the market during a broad downturn. According to this value of beta, EME may be a stock for investors with a portfolio mainly made up of low-beta stocks. This is because during times of bullish sentiment, you can reap more of the upside with high-beta stocks compared to muted movements of low-beta holdings.
Does EME’s size and industry impact the expected beta?
With a market cap of UK£49.68M, EME falls within the small-cap spectrum of stocks, which are found to experience higher relative risk compared to larger companies. Moreover, EME’s industry, oil and gas, is considered to be cyclical, which means it is more volatile than the market over the economic cycle. So, investors should expect a larger beta for smaller companies operating in a cyclical industry in contrast with lower beta for larger firms in a more defensive industry. This is consistent with EME’s individual beta value we discussed above. Fundamental factors can also drive the cyclicality of the stock, which we will take a look at next.
Is EME’s cost structure indicative of a high 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 EME’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. Given a fixed to total assets ratio of over 30%, EME seems to be a company which invests a big chunk of its capital on assets that cannot be scaled down on short-notice. As a result, this aspect of EME indicates a higher beta than a similar size company with a lower portion of fixed assets on their balance sheet. This is consistent with is current beta value which also indicates high volatility.