For NovaGold Resources Inc’s (TSX:NG) shareholders, and also potential investors in the stock, understanding how the stock’s risk and return characteristics can impact your portfolio is important. Generally, an investor should consider two types of risk that impact the market value of NG. The first risk to consider is company-specific, which can be diversified away when you invest in other companies in the same industry as NG, because it is rare that an entire industry collapses at once. 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.
Not all stocks are expose to the same level of market risk. A widely-used metric to measure a stock’s market risk is beta, and the broad market index represents a beta value of one. Any stock with a beta of greater than one is considered more volatile than the market, and those with a beta less than one is generally less volatile.
What is NG’s market risk?
With a beta of 2.3, NovaGold Resources is a stock that tends to experience more gains than the market during a growth phase and also a bigger reduction in value compared to the market during a broad downturn. Based on this beta value, NG 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. TSX:NG Income Statement Oct 13th 17
Could NG’s size and industry cause it to be more volatile?
With a market cap of USD $1.72B, NG falls within the small-cap spectrum of stocks, which are found to experience higher relative risk compared to larger companies. In addition to size, NG also operates in the metals and mining 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 metals and mining industry, relative to those more well-established firms in a more defensive industry. This is consistent with NG’s individual beta value we discussed above. Fundamental factors can also drive the cyclicality of the stock, which we will take a look at next.
Is NG’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 NG’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Given that fixed assets make up less than a third of the company’s total assets, NG doesn’t rely heavily upon these expensive, inflexible assets to run its business during downturns. As a result, the company may be less volatile relative to broad market movements, compared to a company of similar size but higher proportion of fixed assets. This outcome contradicts NG’s current beta value which indicates an above-average volatility.
What this means for you:
Are you a shareholder? You could benefit from higher returns during times of economic growth by holding onto NG. Its low fixed cost also means that, in terms of operating leverage, it is relatively flexible during times of economic downturns. Consider the stock in terms of your other portfolio holdings, and whether it is worth investing more into NG.
Are you a potential investor? I recommend that you look into NG’s fundamental factors such as its current valuation and financial health. Take into account your portfolio sensitivity to the market before you invest in the stock, as well as where we are in the current economic cycle. NG may be a great investment during times of economic growth.
Beta is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on NovaGold Resources for a more in-depth analysis of the stock to help you make a well-informed investment decision. But if you are not interested in NovaGold Resources anymore, you can use our free platform to see my list of over 50 other stocks with a high growth potential.
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