Definition:

Beta is a measure of a stock's volatility in relation to the overall market. It indicates the tendency of a security's returns to respond to swings in the market.

Formula:

Beta = Covariance(Return of the stock, Return of the market) / Variance(Return of the market)

How to use the metric:

Investors use beta to understand a stock's market risk compared to the market as a whole. A beta greater than 1 indicates that the stock is more volatile than the market, while a beta less than 1 means it is less volatile. A beta of 1 implies that the stock's price will move with the market.

Limitations:

Beta is based on historical data and may not predict future volatility accurately. It also does not account for new information or changes in a company's fundamentals. Additionally, beta assumes that past market movements will be indicative of future movements, which may not always be the case.

Applies to:

Beta is most applicable to industries with a high correlation to the overall market, such as technology, consumer discretionary, and financial sectors, where stock prices are more sensitive to market movements.

Doesn't apply to:

Beta may not be as useful for industries that are less correlated with the market, such as utilities or consumer staples, where companies tend to have more stable and predictable cash flows regardless of market conditions.

Summary:

Beta is a useful metric for assessing a stock's market risk and volatility relative to the market. While it provides insights into how a stock might react to market changes, it has limitations due to its reliance on historical data and assumptions about future market behavior. It is most effective in industries closely tied to market performance and less so in stable, defensive sectors.