What Is Unlevered Beta?
Let me explain unlevered beta directly to you. Beta measures market risk, and unlevered beta, or asset beta, assesses the market risk of a company without considering its debt. When you 'unlever' a beta, you're removing the financial effects of leverage, which isolates the risk coming purely from the company's assets. In essence, this shows how much the company's equity contributes to its overall risk profile.
Key Takeaways on Unlevered Beta
You need to know that levered beta, often just called beta or equity beta, measures market risk by factoring in both debt and equity in a company's risk profile. Unlevered beta strips out the debt to focus only on asset-related risk. A high debt-to-equity ratio typically increases the risk of a company's stock. Remember, a beta of 1 means the stock matches the market's risk, while values above or below 1 indicate higher or lower risk thresholds compared to the market.
Understanding Unlevered Beta
Beta is the slope from regressing a stock against a benchmark like the S&P 500 Index. Leverage, which is the ratio of debt to equity, is a key factor in beta. Levered beta captures the risk of a firm with both debt and equity in its structure relative to market volatility. Unlevered beta, on the other hand, removes the effects of debt from the capital structure. By comparing unlevered betas, you get a clear view of the risk you're taking on when buying the stock, without the noise from varying debt levels.
Consider a company increasing its debt, which raises its debt-to-equity ratio. This means more earnings go toward servicing debt, increasing investor uncertainty about future earnings. That makes the stock seem riskier, but it's not due to market risk—it's leverage. Isolating and removing that debt component gives you unlevered beta.
The level of debt affects a company's performance and sensitivity to stock price changes. Unlevered beta treats the company as if it has no debt, stripping it from the calculation. Since companies have different capital structures, calculating unlevered beta lets you compare them directly or against the market, focusing only on asset sensitivity to the market.
To calculate unlevered beta, you need the levered beta, the debt-to-equity ratio, and the corporate tax rate.
The Formula for Unlevered Beta
Here's the formula you use: Unlevered beta (asset beta) = Levered beta (equity beta) / [1 + ((1 - tax rate) * (Debt / Equity))]. This adjustment accounts for the tax shield on debt.
Systematic Risk and Beta
Systematic risk comes from factors outside a company's control, like natural disasters, elections, inflation, or wars—you can't diversify it away. Beta measures this systematic risk or volatility for a stock or portfolio.
Beta compares a stock's price volatility to the broader market. Higher beta means higher risk; lower beta means less risk. A beta of 1 matches the market's risk. A beta of 2 means twice the volatility, while less than 1 means lower volatility and risk.
Example of Unlevered Beta
Take Tesla, Inc., as of November 2017. Its levered beta (BL) was 0.73, debt-to-equity ratio was 2.2, and corporate tax rate was 35%. Using the formula: BU = 0.73 / [1 + ((1 - 0.35) * 2.2)] = 0.30.
Unlevered beta is usually equal to or lower than levered beta since debt is typically positive. If unlevered beta is positive, you might invest when prices are expected to rise. If negative, invest when prices are expected to fall.
How Unlevered Beta Helps Investors
Unlevered beta removes debt effects, giving you clarity on the risk from assets alone. It lets you compare companies with different debt levels or against the market, focusing on equity sensitivity.
What Is Beta?
Beta (ß) measures market risk, specifically the volatility or systematic risk of a security or portfolio compared to the market. It's the slope from regressing the stock against an index like the S&P 500, showing how the stock's returns respond to market swings.
What Is Levered Beta?
Levered beta measures risk for a firm with debt and equity, relative to market volatility. Leverage is key here. A levered beta over 1 (positive or negative) means greater volatility than the market; between -1 and 1 means less.
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