Financial Times

Point of View
Risks and returns of listed companies
By Dinesh Ranasinghe

Company Beta
ACAP 0.68
CFIN 1.10
COMB 0.77
DFCC 0.68
NDB 0.47
HNB 1.02
NTB 1.24
LOLC 0.92
SEYB 1.26
CTC 0.68
DIST 1.30
HAYL 0.84
JKH 0.87
SPEN 0.48
LHCL 0.98
GHL 1.74
TAJ 1.57
GRAN 1.29
RCL 1.04
RICH 1.31
LLUB 0.74
SLTL 1.32

With the global fund managing community identifying Colombo Bourse as an emerging market for its performances in the recent years, the investors and analysts are also keeping a close tab on risks and rewards of individual listed companies. As investors anticipate higher returns for higher risks, an unclear area is the relationship of the overall market and the individual companies in terms of risks and returns.

In investment finance, risk is known as the deviation from expectations, either favourable or not. There are two main components of risk; systematic and unsystematic risk. The latter refers to the diversifiable risk, which can be mitigated through diversfying one’s portfolio. Hence, this risk does not entail additional return for an investor.

Systematic risk is the risk of holding a particular share. As the overall market moves, each individual share is more or less affected. To the extent that any share participates in such general market moves, that share entails systematic risk. This specific risk is the risk, which is unique to an individual company and is measured by the factor known as ‘beta’, and as per the beta factor the risk premium of investment should defer over the risk free return. That means an investor should yield a return similar to a money deposit plus a risk premium according to beta which resembles additional risk.

A company's beta is that company's risk compared to the risk of the overall market. If the company has a beta of 2.0, then it is said to be two times more risky than the overall market and thereby an investors required return on investment also should be relatively high to compensate for the additional risk. Return maybe either dividends or share price appreciation.

The above table consists of such beta factors compared to the overall market movement; the All Share Price Index (ASPI). As JKH beta factor is 0.87, it signals that it is stable than the overall market movement, thus shareholder return should be more than that proportion of the risk premium of investment over a money deposit. In contrast, Distilleries Ltd is more sensitive to overall movement and it would be 1.3 times the overall market movement. Thus if the market returns appreciate, JKH would appreciate 84% whilst Distilleries would appreciate 130% or vice versa. Hence Distilleries should carry greater returns to investors for bearing additional risk; returns should generate 1.2 times risk premium over money deposits. With the facts presented it is evident that Aitken Spence is more stable (less risky) and Distilleries is more sensitive (more risky) to overall market movements.

However, the Colombo Bourse is considered small and manipulative, which generates second thoughts on risk-return methodologies. Nevertheless higher risks should always encompass higher returns and vice versa.

Back to Business