Understanding Unlevered Beta

Unlevered beta, also known as asset beta, measures the risk of a company’s stock without the impact of debt. It isolates the company’s business risk by removing financial leverage, making it easier to compare companies with different capital structures.

Investors and analysts use unlevered beta to evaluate a company’s inherent risk compared to the broader market. It is particularly useful in valuation models like the Capital Asset Pricing Model (CAPM), which determines the required rate of return on an investment.

Common Challenges Related to Unlevered Beta

While unlevered beta is a useful metric, it comes with challenges, including:

• Debt Assumptions: Removing financial leverage requires accurate debt and equity data.
• Industry Comparisons: Different industries have varying risk levels, making direct comparisons tricky.
• Market Conditions: Beta values fluctuate based on economic cycles and stock volatility.
• Data Availability: Calculating unlevered beta requires reliable market data, which may not always be available for private firms.

Step-by-Step Calculation of Unlevered Beta

Unlevered beta is derived from levered beta (equity beta), which includes the effects of debt. The formula for unlevered beta is: βunlevered=βlevered1+((1−Tax Rate)×DebtEquity)\beta_{\text{unlevered}} = \frac{\beta_{\text{levered}}}{1 + \left( \frac{(1 – \text{Tax Rate}) \times \text{Debt}}{\text{Equity}} \right)}

Where:

• β_unlevered = Unlevered beta
• β_levered = Levered beta (market beta of the company)
• Debt = Total debt of the company
• Equity = Total equity of the company
• Tax Rate = Corporate tax rate

Example Calculation

A company has:

• Levered beta (β_levered) = 1.5
• Debt = £200 million
• Equity = £800 million
• Tax rate = 25%

βunlevered=1.51+((1−0.25)×200800)\beta_{\text{unlevered}} = \frac{1.5}{1 + \left( \frac{(1 – 0.25) \times 200}{800} \right)} =1.51+(0.75×0.25)= \frac{1.5}{1 + \left( 0.75 \times 0.25 \right)} =1.51.1875=1.26= \frac{1.5}{1.1875} = 1.26

Thus, the unlevered beta is 1.26, reflecting the company’s market risk without debt influence.

Practical and Actionable Advice

• Compare Within Industries: Use unlevered beta to compare companies with different capital structures in the same sector.
• Use for Private Companies: Apply industry-average unlevered beta when valuing private firms.
• Monitor Economic Cycles: Beta values fluctuate, so reassess periodically for accuracy.
• Leverage in CAPM: Use unlevered beta in CAPM to determine a company’s fair cost of capital.

FAQs

What is unlevered beta?

Unlevered beta measures a company’s risk without considering debt, reflecting only its business risk.

Why is unlevered beta important?

It allows investors to compare companies with different capital structures on an equal basis.

How does unlevered beta differ from levered beta?

Levered beta includes financial risk from debt, while unlevered beta removes debt effects.

How is unlevered beta calculated?

It is calculated using the formula: βunlevered=βlevered1+((1−Tax Rate)×DebtEquity)\beta_{\text{unlevered}} = \frac{\beta_{\text{levered}}}{1 + \left( \frac{(1 – \text{Tax Rate}) \times \text{Debt}}{\text{Equity}} \right)}

When should I use unlevered beta?

Use it when valuing companies in mergers, acquisitions, or capital structure comparisons.

Can unlevered beta be negative?

Yes, but it is rare. A negative beta suggests the stock moves opposite to the market.

How do I find a company’s levered beta?

Levered beta is available in financial databases like Bloomberg or calculated using historical stock returns.

What does a high unlevered beta indicate?

A high unlevered beta suggests a company has significant business risk, regardless of its debt.

How do industries affect unlevered beta?

Cyclical industries (e.g., tech, energy) typically have higher betas than stable industries (e.g., utilities, healthcare).

Is unlevered beta the same as asset beta?

Yes, both terms are used interchangeably to describe business risk without leverage.