Knowing This Number Can Save Your Portfolio From Disaster - The Motley Fool - Financial Daily News Site

Knowing This Number Can Save Your Portfolio From Disaster – The Motley Fool

This is a scary time to invest in the stock market. The S&P 500 has fallen by 17% since the start of the year, the Nasdaq Composite is down by almost 28%, and many popular growth stocks have been struggling, including big names like Tesla (TSLA 6.09%) and Moderna (MRNA 5.95%), which have performed even worse than the indexes.

In short, a lot of portfolios are on the downward slope of a roller-coaster. But if you want to invest in a way less likely to test your tolerance for shocks, there’s a metric that can help: beta. 

Couple using a computer.

Image source: Getty Images.

Investors should always look at a stock’s beta

Beta is a measure of an investment’s volatility based on how closely its performance mirrors that of the broader market. If a stock’s beta value is greater than 1, it has in the past exhibited wider swings than the market — and you can generally expect that it will continue to do so. Meanwhile, stocks with a beta that’s closer to zero will likely be calmer.

An example of a relatively safe stock is Johnson & Johnson (JNJ 0.05%), which has a one-year beta value of less than 0.5. In contrast, Tesla and vaccine maker Moderna have betas of well over 1.

JNJ Beta (1Y) Chart

JNJ Beta (1Y) data by YCharts

In the above chart, Moderna’s beta actually went negative at one point amid some volatile stock movement. In early November, the company slashed its sales forecast, which sent its shares crashing at a time when the S&P 500 was fairly stable — hence, the brief period where Moderna’s beta went in the opposite direction of the markets. But on Nov. 26, when the World Health Organization declared omicron a COVID-19 variant of concern, shares of Moderna jumped as much as 28% and quickly reversed the trend. Either way you look at it, the stock’s beta has been nowhere near zero and is incredibly volatile.

In the case of Tesla, there’s no question that while the stock has been a great investment for many people, it has also proven to be risky. The excitement surrounding electric vehicles and the notoriety of CEO Elon Musk have their benefits for Tesla shareholders as the hype generated can send the stock higher. But because of that, its valuation has also gotten out of control, hitting a market cap of $1 trillion last year. The stock has now been declining sharply in recent months, again demonstrating its volatility.

High-beta stocks can take your portfolio on a roller-coaster

Using standard deviations to assess volatility, the following chart shows just how wildly Tesla and Moderna have moved compared to Johnson & Johnson over the past year:

JNJ 30-Day Rolling Volatility Chart

JNJ 30-Day Rolling Volatility data by YCharts

Even before the start of this rocky year, there were ways to differentiate safe stocks from riskier ones — Tesla and Moderna didn’t suddenly become volatile investments in 2022.

Johnson & Johnson’s business isn’t built around hype or dependent on a COVID-19 vaccine — or any other single product — so investors don’t have much of a reason to get too excited or too pessimistic about the stock. That makes this healthcare company a more-suitable investment for risk-averse investors. And its 6% returns this year look impressive compared to Tesla and Moderna, which are both down more than 35%. 

Focusing on beta values of less than 1

If you don’t want to worry as much about your stocks’ near-term movements, then a good plan would be to base your portfolio on low-volatility stocks with low beta values. With that strategy, you can minimize the damage to your portfolio during downturns. And at the same time, you could uncover low-risk investments that you’ll want to hang onto for years.

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