From the course: Finance Foundations

Beta: Examples

From the course: Finance Foundations

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Beta: Examples

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Let's discuss some real beta examples. If you are fearful of your job, if the economy is going down, you're fearful of a recession, then you are not going to run out and buy a new car. But then, when the economy goes back up, lots of people want to buy cars. They've got this pent-up demand. That relation is reflected in a high beta. Consider Bank of America. Banks, especially large banks, have started engaging in more risky behavior. They're selling derivatives. They're trading derivatives and collateralized debt instruments and mortgage-backed securities, which all sounds very exotic and scary. And it is scary because what it has done is this, when the broad economy is doing well, large banks such as Bank of America do great. When the economy goes down, these banks get killed, they get hammered. They have a large beta risk. When the economy goes up a little, the prospects for these banks go up a lot. Now let's consider companies with beta around 1. Google, Microsoft, and Apple all have beta around 1. This reflects the broad importance of technology in our economy. The economic prospects of these technology companies pretty much track the economy. When the economy is strong, these companies are strong. When the economy goes down a little bit, they go down a little bit. They have betas of around 1. Okay, so what does it mean for a company to have a beta that's quite low? Well, McDonald's and Walmart have betas that are quite low because even when the economy is down, you need to buy clothes, you need to buy groceries, and you need fast food. So even when the economy is down, you still need those things. When the economy is up, you still need about the same number of things. When the economy goes up, you don't all of a sudden decide that you need five Big Macs. One will probably do. So the fluctuations of performance of Walmart and McDonald's are almost independent of what happens in the broad economy. One other industry that is almost immune from broad economic effects is Altria. You may know Altria by its older name of Philip Morris. They sell cigarettes. Even when the economy is down, smokers still need to buy cigarettes. Even when the economy is up, they're still buying about the same number of cigarettes. A low beta means a company is not really impacted by broad economic movements.

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