The capital asset pricing model (CAPM) asserts that the anticipated return of a security is related to its beta. Beta is a representation of the systematic risk, which cannot be eliminated simply by means of diversification.
According to CAPM, the term ‘beta’ simply means the covariance of a security’s return while the return is obtained from the market portfolio. Dividing the covariance to the market variance standardizes the relationship between the anticipated return and accounting beta.
Although the beta is estimated from CAPM, the model does not provide any information regarding the factors that affect beta. This particular issue of CAPM and beta and their relationship has been of much interest to finance academicians right since the development of CAPM. Many researchers from financial and statistical backgrounds have attempted to identify the underlying economic phenomenon that determines beta with little or no success. As the accounting data reflects the underlying economic phenomenon, the relationship between the CAPM beta and accounting variables has been of concern to many researchers.
The beta of a security can be anticipated by putting a regression return against the market return. Therefore, beta can be anticipated as long as there is enough historical return data on a particular company’s stock is available.
When a company’s stock is not traded in the stock market or if it is newly listed, it is impossible to calculate the beta of that company’s stock. This particular issue provided researchers another avenue for research for analyzing the relationship between beta and the accounting variables. If a model that properly represents this relationship can be established, betas of nonpublic or newly listed companies can be easily estimated.
Although there is a large body of research on the accounting beta topic, these studies are mostly related to the markets of developed countries. There are relatively few studies on emerging markets.
Beta accounting can provide the investor a glimpse of how the security or stock has performed over a specific time. Beta is not useful in predicting stock movement in the future, but it can give the investors an idea of how the investment compares to his investment personality who likes slow growth or high potential.
Beta accounting may help the short-term investors, but the farther away from the calculations, the less reliable the information is. A long-term investor may get only a little benefit from beta calculations. A short-term investor can, however, benefit by calculating the basics and following the trend over the past year to predict the stock’s overall volatility for a few months ahead.
Note − Stock analysis can either make money or save money, and beta accounting can be a great help. Beta accounting compares the stock’s return with the overall market volatility for the same time period.