If you're even a bit serious about analyzing a stock  whether you're going to use the Capital Asset Pricing Model (CAPM) or whether you're just trying to know the stock's beta to build up some intuition  you should calculate the beta yourself. Calculating the beta yourself is easy to do and if you either aren't able to do it or are unwilling to do it, you should probably not even be thinking about analyzing stocks at all (instead, you should stick with a far more passive strategy that involves mutual funds and ETFs). Any serious investor and financial market participants will always calculate the beta on his or her own even if just to do a doublecheck against a number provided from a thirdparty source. However, in case you need some reasons to calculate a stock's beta on your own, here are 4 good ones: 1. Calculating a stock's beta yourself will allow all relevant information (until the day of your beta calculation) to be factored inBy calculating the beta yourself, you can literally use all the relevant data available to you through today. A thirdparty provider will most likely have a time lag. This time lag can be a day our two at best, but it could be almost a quarter at worst. Do you really want to have a beta that is almost 3 months stale? That is a ridiculous proposition when you can easily calculate a beta that will capture every available data point  you can calculate a beta in the evening and capture that afternoon's market volatility in your calculation. 2. You'll get to choose your own time horizon for the beta calculationThe beta you want might vary depending on your investment time horizon. For long term investors who have higher risk tolerances, daily price movements might be irrelevant. For traders or more riskaverse investors, daily price changes might be very important. When you calculate your own beta, you can choose how far back you want to go in terms of obtaining your data (eg. your market and stock prices). Deciding how far back to go is useful, but clearly more current data is more useful than old data  there's going to be a limit to how far back you'll ant to go. Regardless, choosing how far back you want to go gives you the ability to capture data points in idiosyncratic times that you might care about (eg. an earthquake, a recession, geopolitical conflict, an election, etc.) 3. Calculating a stock's beta yourself will allow you to decide on your own intervalThe more important and interesting part of calculating your own beta is the ability to choose the tie interval between data points  you can use daily market and stock prices or you can go longer and choose weekly or even monthly prices. Going longer would likely require a longer time horizon so that enough data points exist to perform soldi statistical analysis, but you're really in control when you calculate your own beta and you can decide what you care about. If you think weekly price changes are more relevant to you than daily gyrations, you can easily use that when calculating your own beta instead of having to rely on the assumptions and desires of a thirdparty. 4. Calculating a stock's beta will build your intuition regarding stocks, return time series, risk, and finance in generalFinally, you should calculate your own beta because it's easy to do and it will build your intuition of what beta is and what it represents. The more intuition you have, the less likely you are to make foolish investing mistakes  the more intuition you have the less likely you are to be led astray.
Once you understand the what the beta of a stock is and what it represents from a finance and a risk perspective, the next step is calculating it. Reading the theory behind the beta is important, but at some point actually calculating a stock's beta for yourself will prove more useful than reading another paragraph of finance theory. Here, we'll walk through a basic example of how to calculate the beta using MS Excel. We'll use the S&P 500 as a proxy for the market and we'll calculate the beta of Facebook (FB) stock. Step 1: Obtain Daily Stock and S&P 500 Prices for 1 YearThe first step is to obtain daily prices of both the S&P 500 and the stock we're looking at (Facebook in this case) for a period of 1 year. We'll want at least one year's worth of prices in order to capture a full year's economic cycle, include all of the seasons, holidays, and any unique things that might influence the market over the course of a year in our data set. We'll want to make sure that the dates align  we want to make sure that for every day we have both an S&P 500 piece and an FB price. Basically, what you want to avoid is a situation where you have the S&P 500 price for a day but don't have the FB price for that same day (or vice versa). This should be easy if you're using stocks from the US as bank holidays will generally coincide. A final point to note is that you'll want the adjusted closing price for each day (as opposed to the general closing price). The adjusted closing price takes things like stock splits into account. Imagine a stock split occurred for the stock you're analyzing halfway through your yearly timeframe  this would make it seem like there was a huge price drop. To avoid this, adjusted closing prices (which are readily available online alongside normal historical closing prices) take this into account and provide (usually) a postsplit price for the entire timeframe. As to where to obtain the data, that should be easy in today's world  you can go to any of the major finance websites to download historical data or you might use your own brokerage account's platform. You can also use a paid data provider, but that's not a necessary expense for most people. Step 2: Get the Stock and S&P 500 Price Data Neatly into One Excel FileNext, you'll want to copy the data into the same Excel file so you can work with it. This should be easy. Take care to leave a few columns between the data so that you can do the next calculations we'll go over below. Step 3: Calculate the Daily Returns for the Stock and the S&P 500Next, you'll want to calculate daily returns (eg. daily price changes) for the S&P 500 and FB. This can be done in two ways: simple return: (today  yesterday)/yesterday log return: ln(today/yesterday) For the most part, simple returns will suffice. Sometimes log returns are useful because they inherently assist with normalizing the data, but that's both beyond the scope of this discussion and unnecessary for us here. It's easy to calculate simple daily returns in Excel (see the formula in the image below). Once you have a single cell filled out, you can drag the cell all the way to the bottom to create a time series of daily returns for both the S&P 500 and FB. Note that for the very final day (here it will be the first day in our time series), you won't be able to calculate a return  you'll get an error message in Excel. This is because you won't have a price for the previous day and you'll effectively be dividing by zero. This is not relevant for our purposes and this can safely be ignored. Recall that the beta can be calculated by using the following formula: beta = cov(x,y)/var(x) where x is the stock and y is the S&P 500 and where var(x) does not equal 0. So, we must calculate two things:
You can see this in the below images  notice the highlighted formulas and the sections of the Excel sheet they reference. Finally, you simply divide the two obtained numbers per the above formula  notice this in the image below where we divide the obtained covariance by the obtained variance. We now have our beta for FB  it's 0.861 as of the end of February 2017  remember that this can change as the market changes and as Facebook changes. We'll notice that the beta is less than 1  this means that Facebook stock is less volatile than the market (as represented by the S&P 500). Step 4: Calculate the Two Subcomponents of the Beta FormulaA Bit of Intuition Building  Let's Graph the Stock MovementsWe now have our beta, but let's go even deeper to build some intuition around the number. Below, we have created two portoflios, each consisting of $10,000  at the outset, we invest the full $10,000 in either the S&P 500 or Facebook. So, at the beginning of our time series (February 26, 2016), we have the following:
We're doing this because we need to somehow compare the prices  if we only look at the movement of one share of the S&P 500 vs one share of FB, we won't get a clear picture because the starting numbers are different. What we care about is not the absolute amounts, but the relative movements of both. Below you'll see a graph of how the portfolio would have moved throughout the year  this is literally what would have happened had $10,000 been invested as we described above. Here we see some interesting things: A precursor to truly understanding the concept of Beta is an understanding of the difference between systematic (unverifiable) and unsystematic (diversifiable) risk. These terms sound complicated, but they really aren't. Here's a very brief review of the difference between these two types of risk:
Keeping in mind the above definitions, it would be useful to know how much systematic risk you are being exposed to with a given security (eg. a stock) relative to the market as a whole. Stated another way (and hopefully more simply), if you're going to hold a stock, it's useful to know how risky that stock is relative to the market  this knowledge will allow you to understand how the stock will fit into an already diversified portfolio and it will also allow you to use the important Capital Asset Pricing Model (CAPM) down the line. Stated yet another way for the purposes of clarifying a possibly confusing topic, the beta of a stock will allow you to know the market risk of the stock (the risk arising from general market factors)  it is not, however, a measure of the idiosyncratic risk fo the stock. Boats, Water, and Rain: An Example to Help Clarify the Meaning of Stock's Beta and Why We Care About It A question that arose for me in studying finance was in this effect: If we are only looking at systematic (eg. market risk), why would any stock have a different exposure to market risk? If finance theory says that there is a certain risk called diversifiable market risk that you're still exposed to even if you have a diversified portfolio, why would betas be different? Shouldn't all betas be the same? Stated another way, this question might sound like: Why does beta tell you about systematic (market) risk and not unsystematic (idiosyncratic) risk  and why does that even really matter? This question evinced a deep lack of understanding of finance and further study clarified things for me enough so that the question itself seemed foolish. I will attempt to provide context here so that such foolish questions don't arise. Let's leave finance altogether and travel to a port. In that port, there are wooden boats of all shapes, sizes, and designs on the shore. The port is open and you can take any one of them and go out into the water. The port has constant clouds overhead and there is constant rain. This is a unique port b/c the rain is different in different places  if you're standing on the beach and you walk just 10 feet to another direction, the amount and strength of the rain will change. Now, imagine you take a boat out into the water. You'll feel the rocking and the swaying of the water. No matter where you are in the port area, you're going to feel the water. If a heavy wind storm comes in, all boats will be affected. If it's calm today, all boats will be calm. The way your boat feels, however, is going to be based on the design of your boat  a large heavy boat will sway less than a small boat and a swiftly designed boat that can cut through the water will react differently than a rugged boat. Before you go onto the water, in anticipation of the chaotic rain in this unusual port, you can easily construct a quasiroof over your boat to totally protect you from the rain. You can choose to go out with no roof at all and be totally exposed to the rain. You can choose to go out with a poorly made roof and just have limited protection against the rain. You can also choose to go out with a fullybuilt roof and be totally protected from the rain. You go out into the water now and some wind comes in. No matter what you do, your boat will be affected by the water moving. This is like systematic risk  all boats are affected by it. This risk is not diversifiable  no matter what you do, if you're in the water (eg. if you're in the market), you are exposed to this general risk of moving waters (eg. general market risk). So, if a systematic risk is moving water, a unysystematic risk is the rain  you can choose to diversify that risk away by simply putting up the roof we discussed earlier. You don't have to be exposed to it and many people on the water probably aren't because they've put up roofs  this risk is idiosyncratic to each boat and is diversifiable. In choosing a boat, therefore, you might want to think about a few things. For one, you might want to decide if you want a roof up. Another important thing to think about is the shape of the boat. Since you know the water will move and you will always be exposed to that movement, you'll want to know how your boat will move relative tot he movement of the overall water. You'll want to look at each boat and think about whether or not it will move calmly or forcefully whenever the water moves. Forceful movement isn't necessarily bad, but you'll still want to know what kind of a journey you're about to have. This looking at the boat and seeing how it will react to movements of the water is exactly what the beta is about  knowing a stock's beta will allow you to know how the price of that stock will move relative to moves in the market overall. Clearly, the beta then will not tell you about idiosyncratic risks (just like the shape of the boat will not tell you whether or not you'll be exposed to the rain  that's something for you to decide based on your diversification). It's not up to you to control as stock's beta just like it's not up to you to control how the boat will move  the boats are there laid out for you and built already, you can simply choose a prebuilt one. Going further, we now can see that just because the water moves a certain way (eg. just because the market goes a certain way), it does not at all imply that each stock will move the same way. It is obvious when we think of our port  no one would ever question that boats designed differently would move differently in the water. By the same token, it should be easy to see that firms (which are comprised of different people, processes, assets, liabilities, products, knowledge, etc.) will move differently when the overall market shifts and changes. Why do firms move differently with the market?Going a bit further, we can ask what the underlying causes are for different betas (for different movements relative to market risk). We know why the boats move different (because they are designed differently), but understanding why firms move differently is a far more complicated matter. Firms are different in many ways. Some of these ways include:
These things, and much more, clearly influenced the way a firm's cash flows and stock price (which is dependent on both cash flows and overall market sentiment int the short run) will change based on changes in the market. A firm located in a single US state in Middle America that sells basic goods to people of that state exclusively is clearly exposed to less market risk (eg. less geopolitical risk, less market risk, exchange rate risk, economic downturns, etc) than a multinational firm that produces services that businesses generally purchase in prosperous times but can do without in difficult times. Clearly, one firm's beta would be less than the other if the beta is a measure of a firm's relative exposure to market risk. Quick Note on the Beta of the Market The beta of the market (eg. the beta of the S&P 500) is said to be 1. This will make sense further down the line because we will see that the beta is calculated by seeing how a stock's prices more relative to the S&P 500. A beta greater than 1 indicates a stock more volatile than the S&P 500 and vice versa  clearly, then the S&P 500 will have a beta of 1 because it moves with perfect correlation to itself. Another Quick Note on What Diversification Means Now that we've gone through the basics, we must define diversification. True diversification when discussing beta and when saying that an investment is diversified involves holding the entire market  meaning all stocks, all bonds, all real estate, etc. (or a portion of a basket of them). Holding just a diverse portfolio of stocks still exposes the holder to idiosyncratic risk  they are exposed to shocks that only or primarily affect the stock market. Now, it is difficult and cumbersome to use as total market basket  one doesn't really exist because it's hard to value things that don't have regular market prices like stocks. Therefore, most finance texts use a proxy for the market  that proxy is the S&P 500 most of the time. We'll note that this is a weak proxy because it only focuses on 500 major US stocks  ignoring all of the other stocks and asset classes that one could invest in. Keeping that in mind, we can proceed with using the S&P 500 due to the fact that it is commonly used and that it will still produce reliable results and metrics for our use and understanding. And Finally...How to Actually Calculate the BetaWe've spent a lot of words and sentences discussing what the beta is, but without an actual walkthrough of the calculation, the entire concept is likely to still be obscure to those who have not studied finance before. Let's dive right into the calculation. Another way to take the beta is the correlation of price movements of a stock to price movements of the S&P 500 (eg. the market). We talked about risk before this, but in order to actually quantify these concepts, we must move from a world of words to a world of numbers. We can do that by talking about prices  risk can be represented by volatility (by price movements). We can look at the price movements of a stock and the price movements of the S&P 500 side by side and see how the move  they might move in tandem, the stock might move more aggressively than the S&P 500 (more volatile  higher beta), or it might move more calmly than the S&P 500 (lower volatility  lower beta). In order to get the numbers (both the stock you're looking at and the S&P 500), you can simply use the internet to obtain historical prices  it's a relatively simple exercise. You'll want daily prices and you'll want to make sure that the data lines up in terms of day and the exclusion of weekends  you'll want a daytoday match up. Additionally, if any stock splits occurred over the period you're looking at, you'll want to take the postsplit stock price for the entire time period  this will avoid adding a lot of error because if you don't adjust the price it will seem like the price dropped significantly on the day of the split. It's pretty easy to use a postsplit number for the entire period (post and presplit) because most online repositories of historical stock data will do this for you automatically. Next, you'll have to calculate daily returns  this is simply done with the follwoing formula and should intuitively makes sense: return = (today's price  yesterday's price)/(yesterday's price) This is a simple percentage change over a single day and this should be done for both your stock and for the S&P 500. You'll now have a list of daily price changes for both the stock and the S&P 500. The reason we look at price changes is because we want to see how the movements of the stock related to movements of the s&P 500  in effect, we don't really care about the absolute prices of either the stock or the S&P 500 but are only concerned with their movements over time. One important thing to note is that you'll want to capture enough time within your analysis  you'll likely want a full year's worth of data. Finally, you'll compare the price movements of the stock to the S&P 500 using the most commonly used formula for calculating the beta of a stock: beta = cov(x,y)/var(x) where x is the stock and y is the S&P 500 and where var(x) does not equal 0. This formula might seem complicated, but it really isn't  it can be easily explained and easily performed din a program such as MS Excel using the functions COVAR() and VAR() over a list of price changes. Covariance (which is represented by cov in the above formual) is simply a measure of the joint variability of two random variables  it's a measure of the degree two random variables (here the random variables are the price changes) move in tandem with each other. Variance (which is represented by var in the above formula) is simply a measure of how much a random variable (here the random variable in question is S&P 500 price changes) moves about its mean. Once you have the covariance of the stock and the S&P 500 and the variance of the S&P 500, you simply divide the two numbers per the above formula to obtain the stock's beta  you now have a very powerful piece of information telling you how a stock moves relative to the S&P 500 (which is a proxy for the market). You now know how risk the stock is relative to the market and how much risk the stock would add to a diversified portfolio  you now know the systematic (undiversifiable) risk of the stock. We touched on this above, but let's formally review the possible betas:
There are No "Bad" Betas Remember, in no place did we say that any beta measures are bad. A beta of less than 1 is not bad. A beta of greater than 1 is not bad. Beta simply tells you how much the price of a stock varies relative to the market, it does not imply anything beyond that. A beta of less than one might be desirable for a conservative investor while a high beta might be desirable for a more aggressive investor who is looking for more return. A stock's beta tells us a bit about the expected turn of the stock with higher betas indicating higher expected returns  this makes sense because more risk should entail more reward. However, this discussion about translating beta measures into an understanding of a stock's expected return is beyond of the scope of this present discussion.

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