If you are a shareholder in Sequoia Financial Group Limited’s (ASX:SEQ), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. There are two types of risks that affect the market value of a listed company such as SEQ. The first risk to think about is company-specific, which can be diversified away by investing in other companies in order to lower your exposure to one particular stock. The second risk is market-wide, which arises from investing in the stock market. This risk reflects changes in economic and political factors that affects all stocks.
Different characteristics of a stock expose it to various levels of market risk. The most widely used metric to quantify a stock’s market risk is beta, and the market as a whole represents a beta of one. A stock with a beta greater than one is expected to exhibit higher volatility resulting from market-wide shocks compared to one with a beta below one.
What is SEQ’s market risk?
Sequoia Financial Group’s five-year beta of 2.45 means that the company’s value will swing up by more than the market during prosperous times, but also drop down by more in times of downturns. This level of volatility indicates bigger risk for investors who passively invest in the stock market index. Based on this beta value, SEQ can help magnify your portfolio return, especially if it is predominantly made up of low-beta stocks. If the market is going up, a higher exposure to the upside from a high-beta stock can push up your portfolio return. ASX:SEQ Income Statement Mar 17th 18
Could SEQ’s size and industry cause it to be more volatile?
SEQ, with its market capitalisation of AU$32.90M, is a small-cap stock, which generally have higher beta than similar companies of larger size. In addition to size, SEQ also operates in the capital markets industry, which has commonly demonstrated strong reactions to market-wide shocks. Therefore, investors may expect high beta associated with small companies, as well as those operating in the capital markets industry, relative to those more well-established firms in a more defensive industry. This supports our interpretation of SEQ’s beta value discussed above. Fundamental factors can also drive the cyclicality of the stock, which we will take a look at next.
Is SEQ’s cost structure indicative of a high beta?
During times of economic downturn, low demand may cause companies to readjust production of their goods and services. It is more difficult for companies to lower their cost, if the majority of these costs are generated by fixed assets. Therefore, this is a type of risk which is associated with higher beta. I test SEQ’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Since SEQ’s fixed assets are only 1.29% of its total assets, it doesn’t depend heavily on a high level of these rigid and costly assets to operate its business. Thus, we can expect SEQ to be more stable in the face of market movements, relative to its peers of similar size but with a higher portion of fixed assets on their books. However, this is the opposite to what SEQ’s actual beta value suggests, which is higher stock volatility relative to the market.
What this means for you:
You may reap the gains of SEQ’s returns during times of economic growth by holding the stock. Its low fixed cost also implies that it has the flexibility to adjust its cost to preserve margins during times of a downturn. I recommend analysing the stock in terms of your current portfolio composition before deciding to invest more into SEQ. What I have not mentioned in my article here are important company-specific fundamentals such as Sequoia Financial Group’s financial health and performance track record. I urge you to complete your research by taking a look at the following:
- Financial Health: Is SEQ’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- Past Track Record: Has SEQ been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of SEQ’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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