Use R-Squared To Measure How Accurate Beta Is

Beta is a very interesting concept. It measures the correlation of a stock price to an index. If you have not read our previous article on Beta, please do so before continuing further.

Beta is computed using regression analysis. To measure how accurate the Beta calculated is, we need to use R-Squared.

What is Coefficient of Determination (R-Squared)?

Coefficient of Determination (R-Squared) measures the percentage proportion of the variation (or fluctuation) in a stock’s performance that can be accounted for by movements in the market benchmark index, the Straits Times Index (STI), as suggested by Beta.

Simply put, R-Squared is a measure of how well Beta as a line of best fit represents the linear association between a stock’s performance and that of the market benchmark index. Considering the susceptibility of any best-fit line through a random scatter of datat o a certain degree of deviation from each observed data point, it is essential for investors to examine R-Squared alongside Beta to establish the ‘accuracy of fit’.

Is high or low R-Squared preferred alongside Beta?

R-Squared can take on any value between 0% and 100%. A value closer to 100% is preferred in establishing the reliability of Beta estimate as an indication of the proportion of the variance in a stock’s performance that can be accounted for by movements in the market benchmark index.

When using Beta, we recommend looking for stocks with R-Squared of at least 60%.

Where can I find R-Squared at ShareInvestor?

1. R-Squared for every stock can be easily found under the Key Statistics section of the Factsheet.

Source: ShareInvestor.com

For instance, an R-Squared of 65% over 75 days indicates that 65% of the total variation in the stock’s performance can be explained by market-specific elements as suggested by the corresponding Beta estimate of 1.252 while the remaining 35% is attributable to other firm-specific factors.

A lower R-Squared of 45% over the longer term of 500 days indicates a weaker Beta estimate (Beta: 0.984) in quantifying the trend of the volatility of the stock’s performance relative to the market benchmark index. 

2. Screen stocks in the market using both Beta and R-Squared criteria with your preferred parameters for each criteria under the Prices and Other Conditions section of the Market Screener.

Source: ShareInvestor.com