Alpha and Beta Ratio
Alpha Ratio: The alpha is the most widely used ratio in the stock market. It is used to judge the performance of your investments as compared to its benchmark index. It will show how much extra return your investment or portfolio has produced as compared to its benchmark. It will also take into consideration the amount of risk involved in generating this extra return. You can use the Alpha Ratio while investing in a Mutual Fund, Stock, or ETF.
What is good Alpha
- If the Alpha ratio of investment is ‘0’ (zero), it shows that returns from the portfolio are the same as that of its benchmark index.
- If the Alpha ratio of investment is more than ‘0’ (zero), it shows that portfolio returns are outperforming its benchmark index.
- If the Alpha ratio is less than ‘0’ zero, it indicates that the portfolio return is underperforming its benchmark index.
The greater the Alpha Ratio better the performance of investment.
Mutual Fund Schemes having greater alpha show that they are outperforming their benchmark indexing comfortably by taking relative risks. This shows the performance ability of the fund manager.
We can check the alpha ratio of stock for it valuation. Whether it is undervalued or overvalued. It can help your decision while investing in stocks.
How to calculate Alpha Ratio
Alpha = R – Rf – beta ( Rm – Rf )
Where
- R represents Portfolio return
- Rf – Risk-Free return
- Beta represents the systematic risk of the portfolio
- RM represents Market Returns
Alpha ratio shows the excess of return given by investment as compared to its benchmark index for a given risk taken. Alpha ratio is most useful in the case of Mutual fund schemes where it shows the risk-adjusted return over its benchmark index. It helps the investors to judge the performance and ability of the fund manager.
Beta Ratio:-
Beta Ratio is used to measure the volatility of a stock or mutual fund. It shows the relative movement of stocks and MF as compared to the overall market movement. It shows upward and downward movement of stock as compared to overall market up and down movement.
- If the Beta ratio of a stock is 1 ( One ), It indicates that the stock volatility is the same as that of the Market.
- If the Beta of the Stock is more than 1, It shows the stock is more volatile as compared to the market.
- If the Beta value is less than 1, it indicates that the stock is less volatile as compared to the market.
Beta ratio shows the sensitivity of the stock as compared to the overall market. Beta can also be termed as the percentage change in stock as compared to the percentage change in the market.
What is good Beta
High beta ratio stocks are more volatile when compared to overall market movement. They will give multi-bagger returns in the bullish market. Similarly, if the market crashes down, High Beta stocks will fall more as compared to the market.
- Suppose if Stock has a beta value of 1.75. and markets move by 1%. Then stock will move 1.5% as compared to the market.
- Suppose if stock has a beta value of 0.5 %. Then if the market moves by 1%, the Stock will move by only .5%. If the market moves by 2 % then the stock will move by 1%
Frequently Asked Questions:-
1..What is difference between Alpha and Beta Ratios?
Alpha Ratio tells us about extra return generated by our investment like stock, Mutual funds, ETFs over its benchmark. It also takes into consideration the risk taken to generate the returns.
Beta Ratio tells us about the volatility of our investment as compared to overall market movement. You can judge the volatility of your investment. Whether the investment is more volatile or less volatile as compared to the overall market.
2. What is good Alpha Ratio ?
The Greater the Alpha of the portfolio better will be returns. ‘0’ Zero Alpha indicates the same return as that of Benchmark. Alpha more than ‘0’ shows, that investment is outperforming the benchmark. Alpha less than ‘0’ zero shows, that the portfolio is underperforming the benchmark.
3. What is good Beta Ratio ?
The lower Beta value of the Portfolio indicates that the portfolio is less volatile as compared to the overall market. Beta Value ‘1’ shows the same volatility as that of the market. A beta value of more than ‘1’ One indicates Portfolio is more volatile than the market. Beta value less than ‘1’ one indicates less volatility as compared to the market.
4. Alpha Ratio Formula ?
Alpha = R – Rf – beta ( Rm – Rf )
Where
- R represents Portfolio return
- Rf – Risk Free return
- Beta represents systematic risk of portfolio
- RM represents Market Returns