What Is Beta?
Beta quantifies a stock's systematic risk, meaning its sensitivity to movements in the broader market such as the S&P 500. A stock with a beta of 1.5 tends to rise about 15% when the market rises 10% and fall about 15% when the market falls 10%, while a beta of 0.5 implies moves roughly half as large as the market's.
Beta is estimated statistically by regressing a stock's historical returns against the market's returns, and it is the key risk input in the capital asset pricing model.
Levered vs. Unlevered Beta
Observed betas are levered, meaning they reflect both a company's business risk and the extra volatility created by its debt. To compare companies with different capital structures, analysts unlever beta using Unlevered Beta = Levered Beta / (1 + (1 - Tc) x D/E), strip out financing effects, and then relever at the target company's capital structure.
This unlever-relever process is standard when building a WACC for a private company or a division, where no traded beta exists and comparable public companies must be used instead.
Example
Suppose a comparable company has a levered beta of 1.3, a debt-to-equity ratio of 0.5, and a 25% tax rate. Its unlevered beta is 1.3 / (1 + 0.75 x 0.5) = 1.3 / 1.375 = 0.95. Relevering at a target D/E of 0.8 gives 0.95 x (1 + 0.75 x 0.8) = 1.52. Plugged into CAPM with a 4% risk-free rate and 5% equity risk premium, that implies a cost of equity of 4% + 1.52 x 5% = 11.6%.
Why It Matters
Beta translates risk into a number that can be priced, driving the cost of equity and therefore every DCF valuation. High-beta sectors like technology and airlines carry higher discount rates and lower present values for the same cash flows, while low-beta sectors like utilities are valued with cheaper capital.
Interviewers love asking why we unlever and relever beta, testing whether you understand that leverage amplifies equity risk independently of the underlying business.
