Alpha indicates excess returns delivered by the investment, beta indicates the measure of the investment volatility in relation to the overall market. Funds that specialize in high beta stocks — typically growth stocks — tend to perform well in strong bull markets. By learning about beta, investors can better understand the risk they are accepting and refine their portfolios to suit their personal investment goals. It removes the blurring of skill and circumstance and enables investors to determine whether a portfolio manager’s investment strategy is really generating alpha.
By using this formula, you can assess whether your investment portfolio has generated positive or negative alpha. A positive alpha indicates that your portfolio has outperformed the market, while a negative alpha suggests underperformance. Beta is a measure of an investment’s volatility compared to a benchmark index.
How To Sell or Exit Your Mutual Funds in India?
They are two different parts of an equation used to explain the performance of stocks and investment funds. Alpha is a measure of performance regarding investment returns that are better when compared to a benchmark when adjusted for risk. Active investors seek to achieve returns that are higher than a benchmark and can employ a variety of strategies to do so.
- Reviewing both of these ideas will undoubtedly enhance the worth of your stock investment choices and help make clear the precise difference between alpha and beta companies.
- Alpha refers to the measure of an investment’s performance relative to a benchmark index, typically the market average.
- Alpha works best, first of all, when applied to strictly stock market investments.
Portfolio Management
Unlike Beta, which alpha and beta of stocks measures the volatility of an investment compared to the market, Alpha focuses on the excess return generated by an investment. This makes Alpha a valuable tool for investors who are looking to assess the skill of a fund manager in generating returns that are not solely dependent on market movements. One of the key attributes of Alpha is that it is a measure of active return.
Assessing Investment Performance Using Alpha
And if the company is unable to repay its debt on time, the creditors will have a higher stake in the company’s assets than its shareholders. Since stocks with high beta generate high returns, the figure may surpass the inflation rate in the country. To flourish, small and midcap companies need cheap credit and high demand, both of which can be scarce in times of economic turmoil. Once the economy shows signs of recovery—credit conditions get better, and demand picks up—these companies’ performance can also improve. (Note that this is not a prediction; nothing in the stock market is predictable. So, always do your due diligence before relying on market-related information from any source).
Consider whether your investment timeline aligns with the potential volatility of these stocks. Stocks with high beta carry higher risks and can generate high returns. Thus, investing in such stocks after careful evaluation and continual monitoring can help you create wealth. Smallcases are modern investment products that help investors build low-cost, long-term & diversified portfolios with ease. A smallcase is a basket or portfolio of stocks/ETFs representing an idea – an objective, theme, or strategy.
Beta Can Also Be Negative!
For the full year, AES’ adjusted EPS rose 22% to $2.14 from $1.76 in 2023. The company constructed and acquired 3 GW of renewable energy in 2024, as well as constructed a 670 MW combined cycle gas plant in Panama. AES produces power through various fuel types, such as gas, renewables, coal, and oil/diesel. The AES (Applied Energy Services) Corporation was founded in 1981 as an energy consulting company. The corporation now has businesses in 14 countries and a portfolio of approximately 160 generation facilities. The combined company would have revenue between $1,979 million and $1,993 million, 46% of it being subscription revenue.
- For instance, when a stock has an alpha of 1.0, the stock outperformed its benchmark by 1%.
- It is noteworthy that in turbulent markets, low beta stocks show higher stability.
- By design, a 2X leveraged S&P 500 ETF has a beta that is very near to 2 in comparison to the S&P 500.
- This means that it takes into account the specific risks taken by the investor to achieve higher returns.
- The company noted revenue was 28% higher year-on-year to $9.6 billion, and beat estimates by more than $200 million.
- However, not all portfolios are relevant enough to compare to the S&P 500 index.
In this article, we will compare the attributes of Alpha and Beta to help investors understand how they can be used to evaluate investment opportunities. Alpha is a measure of performance, and beta is a measure of volatility. Alpha is a measure of performance on a risk-adjusted basis, while beta is a measure of risk, or volatility, relative to the broader market.
Beta can be described as the responsiveness of an asset’s returns to swings in the market. A security that has a higher beta has more risk, and based on the CAPM, it is expected to offer more returns. Alpha and beta are among the five popular risk ratios in financial investments; others are standard deviation, R-squared, and the Sharpe ratio. They are generally used to determine an investment portfolio’s returns. While you may already be aware or even using both metrics, you may want to know the difference between alpha and beta in trading.
What is Beta in Stock Market?
If Alpha is positive then it is overperforming based for its risk level. For example, if you are looking at two stocks with the same expected return, but one has a higher beta than the other, the stock with the lower beta will be a good choice. This is because the stock with the lower beta will be less volatile than the stock with the higher beta. Beta—also known as the beta coefficient—is a measure of an investment’s historical volatility compared to a market index (usually, the S&P 500). Another important consideration for investors while using this metric is choosing a benchmark index. The alpha value is calculated and compared to a benchmark that matches the portfolio it is being compared with.
In summary, Alpha is a measure of an investment’s performance compared to a benchmark index. It is a measure of active return that takes into account the specific risks taken to achieve higher returns. Alpha is not directly related to market movements and is often used in conjunction with other performance measures to provide a more comprehensive analysis of an investment’s performance.