Why Alpha of a Stock is Important

Alpha of a stock or security refers to a measure which calculates the return generated by a stock in relation to the risk taken for buying the stock or security. In other words alpha is the abnormal rate of return on a stock or security in excess of return predicated by the capital asset pricing model.

If alpha is greater than 0 then it implies that stock has earned excess return than the risk taken for buying that stock, while if alpha is lesser than 0 then it implies that stock has earned less return than the risk taken for buying that stock. If alpha of a stock is equal to 0 then it implies that stock has earned return equal to risk taken for buying that stock.

Alpha of a stock is important when it comes to measuring the performance of the portfolio manager, for example if there are two managers A and B, and A earns return of 30 percent and B earns a return of 20 Percent, however if alpha of the portfolio manager A is less than 0 and Alpha of portfolio manager B is greater than 0 than it implies that manager B has outperformed the manager A. Alpha suggests that though Manager A had earned excess return but he had take too much risk for generating those returns.

1 comment… add one
  • Isaac

    Is it possible that alpha is greater than zero and its security earns an excess return?

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