Analysts estimate the future risk of a stock investment by assessing its volatility and beta, which provide insights into the stock's past performance and how it may behave in the future. They compare the Estimated Rate of Return with the Actual Rate of Return to understand the investment's performance and risk level.
- To estimate the future risk of a stock investment, analysts will calculate the volatility of the stock's past returns and assume it is a reasonable estimate of future risk.
- Volatility is a statistical measure of the dispersion of returns for a given security or market index, often measured by using the standard deviation or variance between returns from that same security or market index.
- Higher volatility indicates a higher risk of the investment.
- Analysts may also use the beta of a stock, which measures the sensitivity of the stock's returns relative to a market benchmark, as an assessment of risk.
- Additionally, they might look at the historical range of the stock's price movements, known as its price volatility, in their analysis.
- It is important to understand both the Expected Rate of Return, which represents what investors anticipate they will earn from an investment on average, and the Actual Rate of Return, which is what investors eventually gain or lose from the investment.
- Riskier investments often have a wider gap between these two rates over time.
- Ultimately, the expectation for future returns often influences a stock's price more than its actual past performance.