Beta Definition – Beta is a relative measure of volatility that is determined by comparing the return on a share to the return on the stock market. In simple terms, greater the volatility more risky the share and higher the Beta. If a company is affected by the macroeconomic factors in the same way as the market is, then the company will have a Beta of one and will be expected to have returns equal to the market. A company having a Beta of 1.2 implies that if stock market increases by 10% the company’s share price will increase by 12% (i.e., 10% × 1.2) and if the stock market decreases by 10% the company’s share price will decrease by 12%.
Beta is a statistical measure of volatility and is calculated as the Covariance of daily return on stock market indices and the return on daily share prices of a particular company divided by the Variance of the return on daily Stock Market indices. While considering market index a broad based index like S & P 500 should be considered.
For the companies, which are not listed in stock exchanges, beta of the similar industry may be considered after transforming it to un-geared beta and then re-gearing it according to the debt equity ratio of the company. The formula for un-gearing and gearing beta is shown below.
Ungeared Beta = Industry Beta / [1 + (1–Tax Rate) (Industry Debt Equity Ratio)]
Geared Beta = Ungeared Beta/[1 + (1 – tax rate) (Debt Equity Ratio)]