Are you paying attention to beta?

By DAVID MOON, Moon Capital Management
February 3, 2008

A weak market exposes a weak mind or a weak stomach. Examples abound.

A financial commentator recently recommended that people pay special attention to the riskiness of the stocks they own, and that the way to do this is to study statistics like beta.

Here's a quick, simplified lesson. Beta is a historic measure that tells you if a stock has tended to be more or less volatile than the S&P 500. A stock with a beta of 1.20 has been about 20 percent more volatile than the overall stock market. If the S&P 500 goes up ten percent, you might expect this stock to go up 12 percent.

Well, that's the theory, anyway.

If stock prices are declining, then you should own stocks with betas of less than 1.00. Their declines should be less than that of the overall market.

Whoops. A lot of people in Knoxville may want to rethink their First Horizon holding. It has a beta of 0.80. In the last six months, however, its stock price has declined 36 percent compared to the 8 percent decline in the S&P 500. That's the exact opposite of what beta says should happen.

I'm not picking on First Horizon. The same can be said of most regional banks, including Regions (beta of 0.64; six month decline of 20 percent), BB&T (0.61, -8%), SunTrust (0.57, -19%) and others.

But those are banks, you say? Well how about media conglomerate Gannett? Beta of 0.73, six month decline of 23 percent.

But nobody reads newspapers anymore?

OK. Try Hershey, the chocolate folks. Diabetes is in a bull market, but Hershey stock is off 21 percent in the last six months despite its 'low risk' beta of a minuscule 0.05.

So why do people so quickly turn to numbers that are, at best, marginally useful? Because in times of anxiety, people want solutions that are simple and easy to understand. They aren't as concerned about whether or not the solution is helpful. This is why weight-loss books often have the word 'easy' in the title. That's why you've never seen a self-help program titled 'Change Your Life in 17 Difficult, Demanding Steps.'

It wouldn't sell, because people want easy.

Why else would people abandon the stock market after prices decline?

In 1966, the Dow Jones Industrial Average stood at 1,000. Sixteen years later, in 1982, it stood at 1,000. People panicked, capitulated and ran from financial assets.

They also missed almost a tripling of stock prices over the next five years.
On a single day in October 1987, the U.S. stock market fell by almost 25 percent. The wealthy investors I know today were buying stocks in the days right after that.

I suspect that the rich people of 2020 are doing the same thing today.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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