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2. The excess return that a portfolio makes over and above what the capital asset pricing model estimates.
Alpha measures risk-adjusted return, or the actual return an equity security provides in relation to the return you would expect based on its beta. Beta measures the security's volatility in relation to its benchmark index.
If a security's actual return is higher than its beta, the security has a positive alpha, and if the return is lower it has a negative alpha.
For example, if a stock's beta is 1.5, and its benchmark gained 2%, it would be expected to gain 3% (2% x 1.5 = 0.03, or 3%). If the stock gained 4%, it would have a positive alpha.
Alpha also refers to an analyst's estimate of a stock's potential to gain value based on the rate at which the company's earnings are growing and other fundamental indicators.
For example, if a stock is assigned an alpha of 1.15, the analyst expects a 15% price increase in a year when stock prices are generally flat. One investment strategy is to look for securities with positive alphas, which indicates they may be undervalued.