Chapter 8 discussed the basic trade-off between risk and return. In the capital asset pricing model (CAPM) discussion, beta was identified as the correct measure of risk for diversified shareholders.

Recall that beta measures the extent to which the returns of a given stock move with the stock market.

When using the CAPM to estimate required returns, we would like to know how the stock will move with the market in the future, but because we don’t have a crystal ball, we generally use historical data to estimate this relationship with beta.

As mentioned in Web Appendix 8A, beta can be estimated by regressing the individual stock’s returns against the returns of the overall market. As an alternative to running our own regressions, we can rely on reported betas from a variety of sources. These published sources make it easy for us to readily obtain beta estimates for most large publicly traded corporations. However, a word of caution is in order. Beta estimates can often be quite sensitive to the time period in which the data are estimated, the market index used, and the frequency of the data used. Therefore, it is not uncommon to find a wide range of beta estimates among the various Internet websites.

Questions

1. Begin by looking at the historical performance of the overall stock market. Typically, on most of the financial websites you can enter S&P 500 and go right to the index’s summary page. You will see a quick summary of the market’s performance over the past 24 hours and 12 months. How has the market performed over the past year?
2. On the summary screen, you should see an interactive chart. Typically, you can chart performance over the last 24 hours, 1 month, 6 months—up to 5 years, or even longer. Select different time periods and watch how the graph changes. On this screen you should also see a menu to select historical prices (historical data). Some websites will not only show daily activity but also weekly or monthly activity. In addition, some websites will allow you to download the data into an Excel spreadsheet.
3. Now let’s take a closer look at the stocks of four companies: Colgate Palmolive (Ticker = CL), McDonald’s (MCD), Microsoft (MSFT), and Tiffany & Co (TIF). Before looking at the data, which of these companies would you expect to have a relatively high beta (greater than 1.0) and which of these companies would you expect to have a relatively low beta (less than 1.0)?
4. Select one of the four stocks listed in question 3 by entering the company’s ticker symbol on the financial website you have chosen. On the screen you should see the interactive chart. Select the 6-month time period and compare the stock’s performance to the S&P 500’s performance on the graph by adding the S&P 500 to the interactive chart. Has the stock outperformed or underperformed the overall market during this time period?
5. Go back to the summary page to see an estimate of the company’s beta. What is the company’s beta? What was the source of the estimated beta? Realize that if you go to another website, the beta shown could be different due to measurement differences.
6. What is the company’s current dividend yield? What has been its total return to investors over the past year? Over the past 3 years? (Remember that total return includes the dividend yield plus any capital gains or losses.) You will have to go to more than one website to find this information. MSN Money (msn .com/en-us/money/markets) gives DPS information over the past 4 years on the detailed Income Statement Financials page. (Be sure to enter the ticker symbol in the quote search box located in the middle of your screen—not the web search box at the top of your screen.) You can use the price information to calculate dividend yield and capital gains yield. Yahoo! Finance provides historical price information.
7. Assume that the risk-free rate is 3%, and the market risk premium is 5%. What is the required return on the company’s stock?
8. Repeat the same exercise for each of the three remaining companies. Do the reported betas confirm your earlier intuition? In general, do you find that the higher-beta stocks tend to do better in up markets and worse in down markets? Explain.