What Is Unlevered Beta?
Beta measures how much a stock moves relative to the overall market, but the raw beta observed from trading data reflects two things at once: the volatility of the underlying business and the amplification created by financial leverage. A company with more debt shows a higher equity beta even if its operations are identical to a peer's, because fixed interest obligations make equity returns swing harder.
Unlevered beta removes that financing effect, leaving a pure read on business risk driven by factors like industry cyclicality and operating leverage. Two competitors with very different balance sheets should have similar unlevered betas, which is exactly what makes the measure useful for comparison and for valuing companies whose target capital structure differs from their current one.
The Formula and the Relevering Process
The standard (Hamada) formula is: Unlevered Beta = Levered Beta / (1 + (1 - Tax Rate) x Debt/Equity). A company with a levered beta of 1.50, a debt-to-equity ratio of 1.0, and a 25% tax rate has an unlevered beta of 1.50 / (1 + 0.75 x 1.0) = 0.86. The same formula run in reverse relevers a beta to any chosen capital structure.
In practice, analysts pull levered betas for a set of comparable companies, unlever each one using its own capital structure and tax rate, average the results to get an industry asset beta, and then relever that average at the target company's expected debt-to-equity mix. The relevered beta feeds into CAPM to produce the cost of equity, which in turn feeds the WACC.
Why It Matters
The unlever-relever process is the standard way to estimate beta for companies without meaningful trading data, including private companies, recent IPOs, and divisions being carved out of a parent. It also corrects for distortions when a public company's own beta is unreliable, whether from thin trading, a short history, or a capital structure about to change materially in a buyout or recapitalization.
This is fertile ground for interview questions. Candidates are commonly asked to write both formulas, explain why betas must be unlevered before averaging across comps, and reason through directionality: adding debt raises levered beta, raises the cost of equity, and increases the riskiness of equity even as cheaper debt initially lowers the overall WACC.
