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Stock Analysis - Beta and Alpha

Beta and Alpha analysis are just two measurements of analysis used to gauge a stocks volatility and possibility of returns. These two measurements are a good source to use and a good place to start research of a stock before buying.

Beta is used for measuring the risk in a stocks price volatility and generally is used when the plan is to purchase and sell within a Short period of time. So day traders would consider this measurement carefully.

When the Beta is:

  • Less than 0- very low volatility. However, a Beta this low is very unlikely.
  • Equal to 0- very low volatility. This is possible, however chances are this will be a hard find.
  • Less than 1- Somewhat more volatile than the previous, but overall more risk.
  • More than 1- This is getting into riskier waters.
As you can see, when the beta increases, the more volatile the stock. There is generally a direct connection between risk and return. Generally the more riskier the stock (higher the beta) the greater return. However, careful consideration needs to be taken when choosing a high risk stock. Much more research needs to be done.

Alpha is used for measuring the difference between the fair and actually expected rates of return on a stock. This is a common measurement used to determine performance of a stock assuming that if a market is returns zero percent. An example: a stocks alpha with an alpha of 1, based on an index (say the S&P), will have a return of 1% if the index returned zero percent. This is the additional return above the expected return. Alpha = α. Risk free rate = rf .

When the Alpha is:
  • αi < rf : the company has decreased value in the company or decrease returns
  • αi = rf : the company has neither decreased or increased value or returns
  • αi > rf : the company has created or increased value or returns
So, these requirements of alpha will show that when alpha is greater, there is more value in the stock compared to the related index or indexes.

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