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How do I unlever beta?

Modified on: 2018/07/17
A:

The act of "unlevering" beta is simply subtracting the impact of debt obligations of a company before evaluating an investment's risk. Unlevered beta is considered useful, because it helps show a firm's equity risk compared with the overall market, as the unrealized benefits of debt are removed from the equation. Unlevered beta is synonymous with "asset beta." Beta is unlevered through the following calculation: beta (levered) / 1 + (1 - tax rate) x (Debt/Equity).

Beta Vs. Unlevered Beta

In technical terms, beta is the slope coefficient of a publicly traded stock that has been regressed against underlying market risks, usually a related index such as the S&P 500. By regressing the stock's volatility relative to a broad index, investors are able to gauge how sensitive any given security might be to macroeconomic risks. However, as companies add more and more debt, they are simultaneously increasing the uncertainty of future earnings. In essence, they are assuming financial risk that is not necessarily representative of the type of market risk that beta aims to capture. Investors can then accommodate for this phenomena by subtracting potentially misleading debt impact. Since a company with debt is said to be leveraged, the term used to describe this subtraction is called "unlevering."

All of the additional information necessary to unlever beta can be found on a company's financial statements where tax rates and debt/equity ratios can be calculated. It is important, however, when making comparisons between different firms to use identical metrics; only compare beta to beta and unlevered beta to unlevered beta.


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