The Beta value is a key variable in the CAPM model which attempts to determine a theoretically appropriate required rate of return of a stock - if that stock (or other asset) is to be added to an already well-diversified portfolio, given that stock’s non-diversifiable risk.
The theory made for a great University thesis but it doesn’t really stand up and here’s why:
If the stock market crashed tomorrow and BHP’s share price fell from $35 to $20 per share, according to the CAPM model, BHP would be a more risky purchase. Why? Because it has just become more volatile.
In reality, if the underlying economics of BHP are unchanged, I would far rather buy it at $20 than $35 thanks very much. It’s common sense, right?
In other words, like many of the classical theories of finance, it’s a clever theory for the mathematics boffins, but in the real world, it’s a load of tripe. As Buffett has proven over decades of outperformance.
Currently in Meningie at the start of the Great Ocean Road, on the limestone coast.
Staying on a beautiful lake (Lake Albert). About 3 days drive to Melbourne for Xmas from here.