How to calculate levered and unlevered beta?

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How to calculate levered and unlevered beta?

Beta is simply a covariance between a company’s stock return and the market return. It reflects the company specific risk – in other words how much company’s stock is affected by the movements of the market.

A beta equal to one means the company has the same level of systematic risk with the market so the same expected return. In this case beta has no effect on WACC since we simply take the market risk.

A beta lower than 1 means the company has lower systematic risk than the market. Power generation, utilities and financial services industries can be considered as good examples to low beta sectors. The companies in this sector are not expected to greatly affect by the movements in the market in general as they provide some kind of necessary goods and services.

A beta greater than 1 means the company has a higher systematic risk than the market. Steel, construction supplies and entertainment industries are good example for high beta sectors. They indicate a greater risk than the market overall so drives our cost of equity upwards.

You may be wandering what levered beta is? We find the company specific risk premium with the beta component. So beta has to reflect the capital structure of the target company. That is what meant by a levered beta – beta is levered with the company’s capital structure.

So how to calculate levered and unlevered beta?

If the target company is public, we can get the historical beta directly from Bloomberg. However if the target company is private, we have to find the beta of publicly listed comparable companies. But these figures are levered means that each reflects the capital structure of the related company, in order to get an average figure, we have to find the unlevered beta for each company, take the average of unlevered betas and lever that average number according to the capital structure of our target company.

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