Beta: Levered and Unlevered
Beta measures market sensitivity. To compare companies' business risk you strip out leverage (unlever), then re-lever to your target structure.
- ✓Interpret beta values above, below, and equal to 1
- ✓Explain why we unlever and re-lever beta
- ✓Use the unlevering formula
A stock's sensitivity to overall market moves. The market has β = 1. β > 1 = more volatile than the market (higher systematic risk); β < 1 = less volatile; β < 0 = moves opposite the market (counter-cyclical).
Example: an ad-and-media conglomerate might have β ≈ 1.16 (16% more volatile than the market), while a casino operator might have β ≈ 2.23 (123% more volatile) because gaming is intensely cyclical.
A company's observed (levered/equity) reflects both its business risk and its debt load. To pull a clean business-risk signal from comparable companies - which all have different leverage - you strip out each one's debt effect (unlever), average them, then re-lever to your target company's capital structure.
Debt adds risk to the equity holders (they're paid last), so a more levered company has a higher equity for the same underlying business. That's why two identical businesses with different debt loads show different observed betas - and why unlevering is necessary to compare them fairly.
A stock has a beta of 1.8. How should you interpret it?